“The latest escalation of the trade war has prompted us to change our baseline view”, BofA’s Ethan Harris wrote Tuesday, in a rather frank-sounding note called “Trade: it hurts”.
Long story short, Harris (and thereby BofA’s economics team), has been forced to reassess things in light of the latest escalations in the trade war. “We think things are going to get worse with more pain to the global economy before a deal can be reached with either China or Mexico”, he laments.
One problem the bank brings up is the wording of Trump’s Mexico proclamation. On Thursday evening, as soon as the details of the White House’s “plan” were official, we fretted as follows:
This seems like an extremely ill-advised decision, and it’s made immeasurably worse by Trump explicitly stating that when it comes to what counts as “success” on reducing illegal immigration, it will be the administration’s “sole discretion and judgment”.
Reading further, it sounds like Trump may consider nothing short of the wholesale “elimination” of illegal border crossings as sufficient to lift the tariffs. That isn’t achievable. Mexico simply doesn’t have the capacity to completely stop illegal immigration into America. It’s literally mission impossible.
Harris voices similar concerns. After calling the Mexico escalation “big in several respects”, he writes that “the way the demands are presented suggests a probing process for the maximum concessions [where] there are clear deadlines for higher tariffs but no guidance on what would constitute a sufficient response.” Contrary to the upbeat rhetoric from some Mexican officials on Tuesday, BofA worries that “several rounds are likely, particularly if Mexico doesn’t retaliate.”
Mexico has suggested they will hit back, but that could make matters worse just as easily as it could compel Trump to rethink things – it all depends on what kind of mood he’s in.
On China, Harris is also concerned. “For the US-China battle striking a deal has become increasingly complicated as China’s whole development strategy is questioned”, he notes.
Over the course of the last month, it’s become apparent that the Trump administration is aiming at far more than reducing the bilateral trade deficit and/or leveling the proverbial playing field. Rather, the Huawei ban clearly suggests Trump is aiming to curtail China’s economic progress. Further, the prospective blackballing of Hikvision tips an even more intrusive approach, as both Mike Pompeo and Mike Pence appear to be laying the groundwork for a broad crackdown on China’s surveillance industry citing human rights concerns.
Notably, Pence’s big China speech has been delayed, which some believe suggests the administration decided against slapping Beijing in the face with a high-profile human rights declaration delivered on the 30th anniversary of the Tiananmen Square protests.
“A US-China optimist might argue that by pushing the big speech toward the end of the month after the controversial June 4 date is a positive sign”, Chris Krueger (from Cowen) said in a note Tuesday. Pence revels in hawkish foreign policy pronouncements. As we wrote last week, it’s one of the few things Mike is good for. The speech – now planned for the end of June – could become “known as The Pence Doctrine”, Krueger posits, conjuring “the Marshall Doctrine and the Long Telegram, speeches that signaled generational foreign policy pivots”.
But a delay in Pence’s speech is hardly enough to adopt an upbeat take on the trade negotiations. BofA’s Harris says he does not expect a deal from the G20 meeting, but does believe Trump will ultimately decide to delay a decision on taxing all Chinese imports. That assumed delay notwithstanding, BofA warns “it will remain a threat” and the bank “expects [it] to have a big impact on equity markets.”
What does the bank mean by “big impact”? Well, Harris throws out “a 20% market correction from the spring peak”, for example. In conjunction with any “pushback from consumers” that would perhaps be enough “to bring the US back to the table with a partial rollback in July or August”, BofA reckons.
Next, Harris delivers the across-the-board cuts to the bank’s forecasts. For the US, they are as follows:
We are once again forced to chop our forecasts and are reducing GDP growth by an average of 0.6pp in the next three quarters. This brings H2 2019 average growth to 1.2% vs. our prior forecast of 1.8%, which is a sizeable slowdown from H1 growth of 2.5%. For annual GDP growth, we are left with 2.4% for this year and 1.5% next year (note that it is hard to bring down annual growth this year given the strong Q1).
This is the second time this year the bank has been forced to slash their growth targets due to trade escalations.
And then comes the Fed call. BofA is now joining Barclays, JPMorgan, Credit Suisse (and who even knows how many lesser desks) in forecasting cuts. To wit, from Harris:
The Fed will not likely sit idle and watch the economy weaken. We are revising our call: we now expect the Fed to cut rates. We look for a 25bp cut in September, another in December and a final one in early 2020. The recent Fed action has made it very clear that the Fed has a dovish bias. The Fed effectively eased by 100bp at the start of the year by shifting expectations from gradual hikes to patience. That was on the back of greater risks from a weaker global economy and tightening in financial conditions. The weakness should be even more compelling this time around. We are forecasting sub-trend GDP growth in 3Q, a manufacturing sector that is contracting, declining business investment and depressed confidence with a sizeable stock market correction. With core inflation stuck below target and low inflation expectations, there is an easy case for the Fed to cut.
Yes, “there is in an easy case for the Fed to cut”. Although, again, there will be no avoiding accusations that the Fed has bowed to the White House. Assuming you buy the economic case for an insurance cut predicated on trade war concerns, it proves that one way or another, Trump will get his way – even if it means holding the global economy hostage.