Macro Weekly – Trump’s terrific trade deal

by: Han de Jong

  • A US-China trade deal would be helpful
  • European economy feeling the drag of cars, temporarilly we hope
  • Mixed Asia data bears close attention
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I recently finished Bob Woodward’s book on the Trump White House: ‘Fear’. A very interesting and enjoyable read. One thing I had not understood about the Trump presidency is the administration’s stance on trade. During the campaign, Trump had developed a clearly protectionist agenda, but during the first year of the presidency not much was heard about it. That has now changed and tariffs have been slapped on sizeable flows of trade. Why the silence on protectionism in the first year of the presidency? The answer seems to be that Gary Cohn, Trump’s first director of the National Economic Council, pushed back protectionist initiatives as much as he could. But he fell out with Trump over the president’s response to the Charlottesville racial incident in August 2017. That appears to have reduced his influence. Cohn was determined to leave the White House after Charlottesville but was persuaded to stay until the tax reform was finished. He left in April 2018. The trade conflict has escalated since.

But now, just days before crucial mid-term elections Trump has allegedly ordered staff to draw up a draft for a deal with China to signal a ceasefire in the conflict. A real deal is still perhaps a long while away, but this is encouraging.

The US economy appears to be moving along nicely. Business confidence in the manufacturing sector, according to the ISM index at least, fell from 59.8 in September to 57.7. That is a big drop for the month, but the level of the index signals a high level of economic growth in an absolute sense.

Consumer confidence, according to the Conference Board’s gauge, rose from 135.3 in September to 137.9, one of the highest monthly readings ever, suggesting that the consumer is in good shape. The financial position of households is healthy and we are counting on consumer spending growth to remain firm in the quarters ahead.

The labour market remains robust and tight. 250,000 new jobs were created on a net basis. That number probably overstates the underlying strength as there was payback from September when the hiring numbers were hit by hurricane Florence.

Average hourly earnings were up 0.2% mom. Due to a base effect (earnings were down 0.2% mom in October last year) the yoy rate accelerated to 3.1%, up from 2.8% in September. That bears watching, but looking at the monthly increases in November and December last year, I would expect the yoy number to ease again in the months ahead.

Europe and the problem of cars: it is temporary, one must assume

The eurozone economy has lost a lot of momentum this year. In the early months, international trade appeared the main culprit. Slowing export growth to China and the escalating trade conflict caused a negative growth contribution from trade. Over the summer, confidence indices appeared to be bottoming out. But more recently, the drop of confidence has accelerated again. This has also been reflected in harder data. Q3 GDP growth amounted to 0.2% qoq, the weakest since 2014. Italian GDP did not even grow at all in Q3. The European Commission’s Economic Sentiment Index fell further in October: 109.8, versus 110.9. It was its 10th monthly decline, although the graph below shows it is still at a level one would consider healthy from an historical perspective.

A new, but presumably temporary problem has emerged in recent months. Car manufacturers appear to be having problems completing certification for new cars following the introduction on 1 September of new rules for emission testing (WLTP rules). As a result, they cannot deliver cars to buyers. In order to prevent stockpiling, output has been cut drastically. Germany is, by far, the largest car manufacturer in Europe. In August, Germany car production was down over 31% yoy and in September over 23%. This has a material impact on overall economic activity in Germany. Car production makes up an estimated 15% of total industrial production. So a 25% drop in car output reduces total industrial production by 3.75%. This is exactly by how much industrial production growth has eased recently. Back in May, industrial production was up 3.6% yoy. In August it was down 0.1% yoy. As manufacturing makes up some 25% of the German economy, the drop in the production of cars is costing somewhere between 0.5% and 1.0% of GDP, if sustained for a full year.

Another aspect here is that buyers may have brought forward their purchases as they feared prices would rise from September on.

The good news is, of course, that car manufacturers will most likely solve these problems before too long. We should then see the reversal of the recent developments. This reversal will be limited, however, by the behaviour of buyers. Anticipating prices to rise following the introduction of the WLTP rules, buyers have brought forward their purchases. Car sales have remained weak in October in a number of countries. Fingers crossed.

All in all, Europe’s economic momentum has weakened in the course of the year. However, the recent weakness is unlikely to be sustained as it is caused mainly by the car sector. One must assume the sector will solve its problems and then economic conditions should improve.

Asia remains a concern (at least to me), but I am still hopeful

Economic indicators in Asia are still mixed. Recent months have seen some improvement in trade flows. The latest trade data from Korea is a case in point. October export values were up 22.7% yoy. This most likely overstates what is going on the ground. Holidays in September had caused a drop of exports in September of 8.2% yoy, leading to pay-back in October. Nevertheless, it was decent news.

Other data from Korea and Taiwan was less encouraging. Industrial production in Korea was down 2.5% mom and down 8.4% yoy in September. This is undoubtedly also caused by the week-long holiday in the latter part of September. Korea’s Markit PMI fell from 51.3 to 51.0 in October. The Bank of Korea’s manufacturing business survey showed the confidence index falling from 78 to 72 in its most recent version to reach its lowest level since early 2017. The confidence index for the non-manufacturing sector dropped from 77 to 75.

The data in Taiwan wasn’t much better. Taiwan’s PMI dropped from 50.8 in September to 48.7 in October. There has been a remarkable drop from a cyclical peak of 56.9 in January.

While some of the data in Asia is clearly weak, I get encouragement from the trade data, the alleged solution to the US-China trade conflict and the knowledge that China’s policymakers are in the process of providing stimulus, albeit modest and targeted.