Friday, 6th of December 2019
“Another such victory over the Romans, and we are undone.”
– Pyrrhus
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There was a little more volatility in stock markets this week after President Trump reignited fears that the trade war with China may drag into next year and that new trade battles with Europe and Latin America are imminent. On Monday, the Donald accused Brazil and Argentina of currency manipulation and announced (on Twitter, of course) that he would reimpose tariffs on imports of their steel and aluminium as punishment. It is true that both countries use a ‘managed float’ system, whereby the government can intervene in currency markets to bias the exchange rate upward or downward according to the needs of the domestic economy, and that the peso and real have fallen against the dollar in recent weeks. The irony, however, is that both governments have actually been intervening to support their currencies against what is a very strong dollar. Argentina is also facing a major political and economic crisis which has put severe downward pressure on the peso and sparked capital outflows and soaring inflation. Given the close working relationship between Bolsonaro’s government in Brazil and the Trump Administration, the latest tariff volley came as something of a surprise. But the US President believes in using uncertainty as a tool of foreign policy – and surprises are one thing that markets can expect.
Further stoking negative market sentiment on Monday, US Trade Representative Bob Lighthizer made several announcements targeting EU trade practices and policies. Firstly, he said that his office would consider increasing the tariff rate due to be levied on $7.5bn of European goods as a WTO-sanctioned punishment for long-standing Airbus subsidies. Secondly, he announced that $2.4bn worth of signature French goods – from champagne to Roquefort cheese – would be subject to a tariff of up to 100% if the French government fails to reverse their decision to introduce a 3% Digital Services Tax on the French sales of large (mostly US) tech companies. (The UK is also due to introduce its own digital tax should efforts to find an international solution fail.) With both sides digging in, a trade war between the US and EU has never been more likely. US economic numbers remain robust – on Friday, labour market data showed that 266k new jobs were added in November, while September and October figures were both revised higher, unemployment fell to 3.5%, and wage growth stabilised at 3.2%. The same cannot be said for Europe where dire German economic data shows a -5.3% YoY decline in industrial output in October. This suggests that an economic conflict with the US is something Europe can ill afford. More worryingly, given the strains in the transatlantic relationship (very much on display this week at the NATO conference in London), such a fight could make reconciliation harder to achieve when Trump leaves office in 2020 or 2024.
Finally, if Monday had not been sobering enough, on Tuesday President Trump suggested that he had “no deadline” for striking a phase-one trade deal with China and that it may be “better to wait until after the [2020] election”. Just last week, officials suggested that an agreement before Christmas was likely and US tariffs planned for mid-December would be cancelled. However, as we have highlighted in these pages before, closed-door negotiations are inherently unpredictable. Public statements must be taken with a pinch of salt, while information that ‘leaks’ from inside the room is often made available to affect the talks and not to inform the public. It is almost certain than in the last few days there has been no change in the US position and that the Donald is trying to squeeze the Chinese side into offering more concessions in advance of the 15 December tariff deadline. Of course, whether he is bluffing on the current offer being insufficient to strike a deal is an unknown factor, for the Chinese negotiators as well as for the rest of us. With Articles of Impeachment being drafted in the House and a vicious political fight expected before the election next year, staking out a tough position on trade will boost his support in battleground states and allow Trump to re-focus the media narrative on his populist swagger and unconventional approach to the Presidency. However, whether he really wants to fight China and Europe at once is not clear given the risks to US growth and business confidence heading into the election. Looking to the immediate future, then, we hope for a Santa rally but have prepared for a Santa sell-off. As election season gets underway in earnest next year, we see more trade battles to come.
In other news this week, a panel of energy ministers from OPEC and major non-OPEC oil producers, such as Russia, agreed to cut oil production in Q1 to avoid a slump in the oil price amid lower seasonal demand from refineries. However, after talks continued into the night on Thursday delegates failed to commit publicly to further cuts beyond March. Negotiations will kick off again today with Saudi favouring deeper and longer-lasting cuts to shore up its fiscal budget and support the price of Saudi Aramco stock. On Thursday, the world’s most valuable company sold 1.5% of its shares in a long-awaited IPO, and at the top of the expected price range. In the past, the Saudi government has suggested a 5% float with the aim of raising roughly $100bn to transform and diversify the country’s economy. However, any future offering would be conditional on oil not tanking in the intervening period. Therefore, despite enormous US pressure to open the floodgates, Saudi Arabia is making the case for at least a 3-month extension. If Riyadh gets its way, which seems quite likely at this stage, oil should get a short-term boost and enjoy support through the first half of next year at least. Without cuts, oil seems likely to at least remain range bound in Q1 with the risk of a subsequent geopolitical or economic upset knocking it off course.
The final topic for this week’s newsletter is the UK general election next Thursday, when Johnson’s Conservatives will go head-to-head with Corbyn’s Labour. Polls give the Tories a comfortable lead while the chance of a Labour majority is close to zero what with the entrenched position of the Nationalists in Scotland. If the polls prove accurate and Johnson gets his majority, the Brexit deal will finally pass (on or before 31 January) and the negotiations over the future relationship between the UK and EU can begin. The ‘political declaration’ suggests that the two parties will seek to have a close trading and security partnership with more room for manoeuvre on regulation and state aid. Whether a tolerably comprehensive deal across these policy areas can be struck before the end of the transition period on 31 December 2020 will only become apparent in time. However, it will be challenging to say the least given the broad scope of negotiations and an extension is likely. This means that although the passing of the Withdrawal Agreement and the end of Parliamentary obstructionism will be important moments in the Brexit process, the saga will not end next Thursday even with a Conservative landslide. Moreover, there are plenty of possible worlds in which the vote goes against the PM. A hung Parliament in which the Tories are the largest party would be a Pyrrhic victory and nigh-on impossible for them to navigate, given that no other party is backing their deal. Labour have a better chance should they seek to form a coalition, but enthusiasm for their left-wing programme will be tepid at best and the Scottish Nationalists have said that their support hinges on a second Scottish referendum to boot. Thus, any scenario other than a Tory majority looks likely to spark more ugly partisan squabbling and perhaps two referendums – on Scottish independence and the EU. Our base case is a Tory majority of 30-50 which would allow Johnson to govern more or less unimpeded. However, UK politics is very volatile at present with many undecided voters, while tactical voting is rife in some constituencies. Uncertainty persists…
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