“Last week trade tensions between the United States and China significantly escalated. President Trump asked US Trade Representative Robert Lighthizer to come up with a list of $200 billion worth of goods to be tariffed at a 10% rate, with the potential for another $200 billion more if China retaliates. The first list of $200 billion could be announced in two to three months’ time.

“So far this news is just threats, however if that changes, up to $450 billion worth of Chinese goods could be taxed (including the $50 billion already announced). That’s compared to $505 billion total U.S. imports from China last year. For context, that total $505 billion is about equal to 2.5% of nominal GDP.”

… may stall steaming US economy

“Elevated trade tensions may start to weigh on business sentiment. If businesses aren’t confident, they aren’t going to invest. Business confidence measures like the National Federation of Independent Businesses’ (NFIB) Small Business Optimism Index are near record highs, as the US economy steams ahead. But, there is anecdotal evidence that trade worries have already started to weigh down sentiment. According to MarketWatch, Raphael Bostic, the President of the Atlanta Fed stated, ‘optimism has almost completely faded among my contacts, replaced by concerns about trade policy and tariffs. Projects under way are continuing, but I get the sense that the bar of new investment is currently quite high.’ Investment spending is a key input into our GDP forecast for this year. We will be watching business sentiment carefully in the coming weeks and months.”

Tariff threats impacting NAFTA negotiations

“Aside from trade action with China, there are other tensions simmering. NAFTA is being renegotiated. The United States exports much more to Canada and Mexico than to China. There is also the looming threat of US auto tariffs. If tariffs on autos become a reality, that will be just as impactful, if not more so, than tariffs on Chinese goods. Autos make up 14% of total imports versus China’s 15%. The auto supply chain is highly integrated with 35% of the value of US auto exports containing imported parts. The more integrated the supply chain, the more risk there is of broader disruptions from any trade restrictions. The threats of auto tariffs plus steel and aluminum tariffs have likely made NAFTA negotiations more difficult to boot.”

Will this matter for the Fed?

“The Federal Reserve (Fed) will be focused on tangible economic impacts from any trade action. Right now, the only tariffs enacted are very small in scope and will likely have negligible effects on the U.S. economy. If broader tariffs do come to pass, the Fed may look beyond the transitory inflationary impacts and be focused on any drags on U.S. economic growth. We suspect the Fed may be less concerned about impacts on global financial markets today as compared to the past.”

How are trade tensions affecting investment?

“The downside risk scenarios of a protracted trade war with China or another country have increased. With more trade announcements in the pipeline, this will likely lead to more down days in the market. Pop ups of risk-off days will keep downward pressure on the U.S. 10-year. In turn, the yield curve, or the difference between long-dated and short-dated government bonds, may flatten further. Upward pressure on the dollar may stay around, and that means that domestically-oriented smaller cap U.S. stocks may continue to outperform larger cap U.S. stocks with more foreign exposure. Trade is a smaller share of overall GDP for the United States as compared to many other developed countries, so U.S. stocks may beat developed market stocks. “

By Robin Anderson, Senior Global Economist

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“The Guardian reports that this region has traditionally been a left-wing (or liberal) bastion, but now the right-wing nationalist, Marine Le Pen, is pinning her hopes of the French presidency on the smattering of small towns in this province and elsewhere throughout France. She is picking up on the same anger and disillusionment that Donald Trump did in the United States just months ago. And a Le Pen victory, while unlikely, would be toxic for the European Monetary Union.”

Tail risk

‘’With this first round tallied, a Le Pen presidency is much less likely than prior to the vote, but still poses a significant tail risk to financial assets. Marine Le Pen wants to leave the euro, but victory alone would not necessarily imply ‘Frexit’: a French exit from the euro or broader European Union. She’d need some sort of parliamentary or court approval to hold a Brexit-like constitutional referendum. And right now, Le Pen’s National Front party has only two seats in Parliament. Parliamentary elections in June could change that, but the likelihood of gaining a majority is extremely slim. In fact, Parliament would likely be hostile to a President Le Pen, leading to plenty of gridlock and not much else. Le Pen’s opposition to the euro would likely significantly strain relations between France and Germany and other euro members.”

“The true problem with a Le Pen presidency would likely be the financial stress that follows. Even a small probability of a French exit from the euro would put significant downward pressure on the currency and upward pressure on French interest rates. Contagion effects could spread to borrowing costs for Italy, Greece, and even Spain. As investors would then sell euro-denominated assets, the U.S. dollar would likely surge. The U.S. 10 year could breach its post-Brexit low of 1.36% (remember, price is inversely related to yield). A very strong dollar could significantly drag down U.S. company profits and exports. In turn, the Federal Reserve (Fed) would pause, if not reverse, its path to higher interest rates. The European Central Bank (ECB) would likely try to pop up the financial system and conduct even more asset purchases.”

“Investors are relieved that the center-left candidate Emmanuel Macron sailed into the second round. Risk assets have rallied hard in response. But Le Pen is still in the race, and the chance of her presidency, while small, looms until the final round of votes are tallied.”

By Robin Anderson, Principal Global Investors’ Senior Economist

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Here, Robin Anderson, senior global economist, Principal Global Investors shares her thoughts on the Fed’s March meeting, and what’s in store for the U.S. economy looking ahead to 2018.

16 March 2017

“Just as everyone anticipated, the Fed moved up rates by 25bp increasing the lower band to 0.75% and the upper band to 1.0%. The Fed’s summary of economic projections didn’t change too much. On the margins, you did see some changes to core inflation; an upgrade in the forecast for GDP in 2018; and the Fed did lower the equilibrium for the employment rate going forward to 4.7%. We also saw the Fed consolidate around three rate hikes this year.

“The Fed’s policy statement emphasised it is taking a symmetric approach to a 2% inflation target. That tells me the Fed will be tolerant of headline inflation getting above 2%, as it’s doing at the moment.

“It seems to me that the economy, being in a better position, will move two more times this year – in contrast to those who expected a more hawkish approach.”

Looking ahead to 2018

“As Janet Yellen has explicitly stated, the Fed hasn’t really considered any fiscal policy changes. There is a real risk that the economy could surprise to the upside and the Fed could be in a situation where they could be in an overheated economy, and could have to raise rates more aggressively.”

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