Message from Jackson Hole: Time is running out for US and China

Highlights:

- Jackson Hole: Monetary policy cannot completely cushion trade war spillovers
-US-China trade confrontation intensifies with a mark-up in tariffs
- Market expects high probability of two more rate cuts from Fed in CY19
- Investors to watch for a series of central bank meets – ECB, RBA, BOC, CBR, Fed

If there is statement which rightly sums up the global macro situation, it's the one from Philip Lowe, Governor, Reserve Bank of Australia.

He famously said “we are experiencing a period of major political shocks” and “political shocks are turning into economic shocks”.

While this is relevant for developments with respect to Brexit and Hong Kong protests, it's most pertinent for the US-China trade war at this point. In the annual Jackson Hole summit in August, central bankers deliberated on economic prospects and challenges as they looked to dodge a possible recession. Following that, the G-7 summit in Biarritz took up issues at hand, from trade (US-China) to environment (the Amazon fire) to military hotspot (Iran).

Also read: FOMC minutes: Fed may go beyond ‘recalibration’; all eyes on Jackson Hole meet

Jackson Hole – Monetary policy is not answer to every macro challenge

The Jackson Hole summit came against the backdrop of the Fed reiterating that trade policy uncertainty appears to be playing a role in the global slowdown and weak manufacturing and capital spending in the US.  Fed Chair Jerome Powell during his speech at the annual symposium clarified further that while monetary policy can help stimulate consumer spending and business investment, it “cannot provide a settled rulebook for international trade”.

The Fed policy can partially cushion the adverse impact of trade war by say, lowering interest cost for US consumers and investors, but it may not be able to stimulate business investment that banks on global growth prospects. So, growing challenge for the Fed is how to fit trade uncertainty into the central bank’s framework for policy decision.

Having said that, Powell too emphasised that the Fed may have to “look through” short-range developments on the trade front as key impact of monetary policy is felt with uncertain lags of a year or more.

Taken together, the Fed still appeared to be keeping a stance of 'recalibration' or 'mid cycle adjustment' for the policy path, at the time of Jackson Hole, even though trade war had already worsened. The US had by then announced imposition of 10 percent tariff on another $300 billion imports from China, which had suspended purchase of US agricultural products.

Trade war intensifies

Trade war is simmering. The tit-for-tat tariffs from the US and China at one point suggested that the situation is getting out of control. China imposed tariff on US goods of $75 billion and the US responded through an increment in tariff of 5 percent on Chinese imports.

Then, both sides tried to play down the escalation. Trump during the G-7 summit softened his approach towards China. However, action in terms of tariff rollback is what would count in days to come.

Street expecting high probability of two more rate cuts

The Fed policy rate range probability has been volatile in the wake of news flow from the Federal Reserve, macro data and changing dynamics of the trade dispute. As of now, there is 48 percent probability for two more rate cuts in 2019. Street is almost certain for a rate cut in the next policy meet on September 18.  This corroborates FOMC surveys of dealers and market participants who expect at least one more rate reduction of 25 bps this year.

CME FedWatch tool: Fed policy rate probability towards CY19-end

Source: www.cmegroup.com

While in the short term, markets may cheer further rate cuts, central bankers at Jackson Hole have cautioned enough that time is running out for both the US and China. Monetary policy itself may not be enough to salvage the situation.

If recent weakening of US PMI is any indication, purchasing managers expected a contraction in manufacturing. And this is a potent warning for US domestic economy which may be underestimating the contagion effect of the global slowdown. If the US economy encounters a sharp slowdown due to trade uncertainty and the global downturn, it would be a “full circle” for financial crisis, which started with US sub-prime meltdown in 2007-08.

Chart: US vs Germany PMI

Source: www.tradingeconomics.com

Against this backdrop, investors need to look up to a series of central bank meetings in September i.e. ECB (Eurozone, September 12), BOC (Canada, September 4), CBR (Russia, September 6) and RBA (Australia, September 3), which can provide a real picture of the global economy and give a clue if competitive accommodative policies are a trend.

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