US’ trade protectionism, weaker sentiments, and what it means for EMs

THIS year, the US has implemented a number of protectionist trade actions. In March, President Donald Trump announced a 25 per cent tariff on steel (10 per cent on aluminium) imports. The US Trade Representative ( USTR) then proposed a 25 per cent intellectual property (IP) related tariff on 1,333 Chinese goods. President Trump had then asked the USTR if it was possible to impose further tariffs on US$$100 billion worth of Chinese goods. Import tariffs in the automotive sector are also being considered. Some progress has been made in trade negotiations but escalation risks remain, since the steel tariff exemption will expire on June 1.

The White House said it will impose a US$ 50 billion IP tariff on Chinese products, with the list published by June 15, 2018.

Emerging markets (EMs) have likely benefitted the most from the trade hyper- globalisation of the 1990s. The abundant and competitively priced labour supply in these countries, together with free trade, led to large FDI inflows, allowing these countries to export their way up the development ladder. Intuitively, this suggests that these countries should also be more vulnerable to a rise in protectionism.

Aside from that, the market’s fixation on Italian politics has diverted attention from a broader set of indicators that suggest a potential near-term reprieve for EMs. UST yields are well off their near-term highs and oil is down circa US$ 5 per bbl. We note, however, that the coast is by no means clear for Ems as a cautious outlook is warranted over the medium term given underlying pressure on US real rates from increased net issuance, lingering supply constraints in the oil markets and the risks associated with US trade policy announcements.

The fragile sentiments in EMs are underlined by the market response to the removal of steel and aluminium tariff exemptions for NAFTA partners and the EU.

On the global front, there has been some unwelcomed evidence in the euro area that indicates a slowdown may extend further into the second quarter ( 2Q), more than we previously assumed.

In the euro area ‘ flash’ PMI composite output recorded unexpected downsides in May, continuing its march lower since the beginning of the year. Both manufacturing output and services confidence were

down over the month, as were forward-looking components.

At the country level, Germany and France composite indices led the move lower. That said, PMIs across the continent remain in expansionary territory, and are well above historical averages.

The US remains the area for which we are most confident about growth prospects, as growth did not soften as much in 1Q on a relative basis and fiscal stimulus is on the horizon. The minutes to the May Federal Open Market Committee ( FOMC) meeting could also indicate that the committee sees downside risks to inflation as having abated and the economy as likely resilient to potential trade and political shocks.

Yet, previous concerns over low inflation have been replaced by hand-wringing over the potential for an inverted yield curve. Changes to the Fed’s forward guidance appear likely as the policy rate nears committee members’ estimates of a ‘neutral’ growth; we think this may occur in June when we expect another 25bp hike in the federal funds rate.

Nevertheless, the emphasis on gradual rate hikes is likely to remain for now. We see little near-term risk of more hawkish rhetoric from the committee given market pricing is broadly in line with the Fed’s dot plot, the need to evaluate the strength of the fiscal impulse, and a desire by many committee members for clear evidence that trend inflation has materially improved.