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‘This Is No Fly In The Ointment’: One Bank Politely Asks You Not To Ignore ‘Supremely Important’ Trade War

"For us, this is supremely important."

Last weekend, at the G-20 meeting in Buenos Aires, global finance leaders agreed that the outlook for growth had deteriorated and one potential risk factor going forward is of course trade.

“Growth has been less synchronized recently, and downside risks over the short and medium term have increased including rising financial vulnerabilities, heightened trade and geopolitical tensions, global imbalances, inequality and structurally weak growth”, the official statement reads.

The reference to growth being “less synchronized” is important. 2017 was defined by the “Goldilocks” narrative, which rested on the twin pillars of synchronous global growth and still-subdued inflation.

The trade war imperils both of those pillars.

2018 has seen a shift in the growth story towards a U.S.-centric narrative defined by the sugar high the U.S. economy is experiencing thanks to the Trump administration’s myopic decision to pile fiscal stimulus atop a late-cycle expansion. That not only risks setting the stage for a “hard landing”, it also risks turbocharging the situation if and when the Phillips curve finally reasserts itself as it’s wont to do in late-stage recoveries.

Meanwhile, outside the U.S., the trade frictions are threatening to undermine growth in China and also in Europe. The Chinese economy was already decelerating and Beijing is walking a tightrope between deleveraging and not choking off credit growth to the real economy. Trump’s trade war complicates that effort.

In Europe, the data abruptly rolled over in Q1 and the timing could scarcely have been worse, coming as it did amid the ECB’s plans to close the curtain on asset purchases. The political turmoil in Italy made things more complicated still.

With no end in sight to the Trump administration’s multi-front trade war, analysts are warning that the longer it goes on, the more likely it is that the “synchronous global growth” narrative will crumble.

“For us, the outlook for global trade is supremely important, and the current trade skirmish should not be seen as just another ‘fly in the ointment’ for markets”, BofAML’s Barnaby Martin writes, in a note dated Wednesday, before adding that “trade tensions put at risk one of the big secular themes of the last few years – namely that of global synchronised growth.”

Do recall that the “Goldilocks” narrative which defined 2017 was responsible for the low volatility regime. If that narrative is no longer viable, it raises the specter of higher cross-asset volatility going forward, especially as developed market central banks look to normalize policy. Here’s BofAML:

Chart 2 shows the distribution of annual GDP changes across OECD countries since 2004. Note that last year was the first time since 2006 that all OECD countries posted positive economic growth rates. The consequence of this was that market volatility fell to unprecedented levels. Economic certainty effectively bred market certainty.


The figure on the right is of course just a simple chart that illustrates how disconnected U.S. equities have become in relation to emerging market stocks, which suffered through their worst quarter since 2015 in Q2.

The Nasdaq and the Russell 2000 are the poster children for American exceptionalism and it’s worth noting that on Tuesday, following the announcement of Xi’s fiscal stimulus push and amid concerns that the $12 billion bailout for U.S. farmers suggested the Trump administration believes the U.S. might be “losing” the battle, the emerging market ETF outperformed the Russell ETF by the most since February of 2016.


Beijing’s promise to be “more proactive” when it comes to fiscal stimulus is important.  China’s now years-long campaign to squeeze leverage out of the country’s labyrinthine shadow banking complex has always been about curtailing “unproductive” credit growth while ensuring that the tightening push doesn’t end up choking off credit to the “real” economy. It’s an extremely precarious effort and in the final analysis, it’s not completely realistic because there’s no real way of knowing where all of the credit extended through shadow conduits ended up or what it ended up financing.

When you squeeze those channels, there’s always – always – collateral damage (figuratively and literally). Last month’s credit data not only revealed the slowest M2 growth in more than two decades, but also showed a contraction in off-balance-sheet-lending, the first in as long as anyone can remember.

In the same note mentioned above, BofAML writes that the deceleration in Chinese credit growth is likely playing a part in tripping up the European economy.

In Europe, after the impressive 0.7% quarterly GDP print at the end of last year, growth slipped to 0.4% in the first quarter of 2018. Emerging Market weakness – in particular China – likely explains some of the loss of Europe’s economic momentum lately, especially given Germany’s export focus. Chart 4 shows the extent to which financial conditions in China have tightened. Looking at Total Social Financing as a percentage of China M2, one can see that the measure has fallen to a record low.


Finally, the bank reminds you that the emerging market jitters aren’t just confined to Turkey and Argentina – this isn’t just a story about idiosyncratic risk.

Moreover, with the US powering ahead economically vis-à-vis the rest of the world, and trade tensions rising,the broader EM complex has suffered. Chart 5 shows the performance of a number of EM currencies versus the US Dollar. We compare two periods: the 2013 Taper Tantrum and this year’s trade spat. As can be seen, it’s not just those counties with obvious current account imbalances (Turkey, for instance) that have seen worse currency performance this year compared to the Taper Tantrum. Plenty of EM currencies have depreciated more vs.the USD in 2018 than in 2013.


The overarching point here (again) is that the trade war has the potential to exacerbate the divergence between the U.S. and the rest of the world when it comes to economic performance.

That divergence, to the extent it manifests itself in ever more ebullient domestic economic data, will continue to elicit hawkish pushback from Jerome Powell’s Fed, which seems keen to guard against overheating. The more hawkish the Fed, the stronger the dollar and the worse the outlook for EM.

Behind it all: Donald Trump, “destroyer of worlds” – and words.





2 comments on “‘This Is No Fly In The Ointment’: One Bank Politely Asks You Not To Ignore ‘Supremely Important’ Trade War

  1. Error404

    An interesting piece, notwithstanding that its primary purpose was of course to attack DJTweet. Fish and barrels come to mind.

    Still, it would have been even more interesting had you thrown into the mix the fact that three of the world’s more important central banks are still engaged in a decade-long endeavour to print their way to prosperity. When the wheels eventually come off this inconceivably rash monetary experiment, and Goldilocks finally dies from a globally synchronised stake through the heart, the Orange Meister will – if he stays on course – receive a lot of the ‘credit’. But some Oscars for best supporting co-conspirators (a new category, to be introduced by the Academy next year) must go to Bernanke, Yellen, Draghi, Kuroda, and Jordan. (I’ve deliberately omitted Carney, because he switched from central banker to self-publicist, scare-monger and hedgie-in-waiting many moons ago.)

  2. Anonymous

    And in the meantime, even more dynamite gets thrown into the US stock market.

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