It’s Fun To Be In The USMCA

04 Mar 2019

John Wyn-Evans

Head of Investment Strategy

The United States are at the centre of multiple trade talks at the moment; negotiating with China, Mexico, Canada and the UK.

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Last week I suggested that global monetary policy, the outcome of trade talks and (more specifically for UK investors) Brexit were the current key macro market influences. A deeper dive into the first of those topics left no room to discuss the others, so this week it’s time address that omission.

Conscious of the risk of Brexit fatigue, I will kick off with trade, which turns out to be timely owing to reported news overnight that the US and China are close to signing a deal that promises to reduce the current tensions. It’s worth reminding ourselves why trade has become such a big issue. On the plus side it has been a boon for the majority of investors and consumers.

Companies have benefitted from being able to source labour and capital inputs from the cheapest (and sometimes more efficient) regions, while also gaining access to new markets. Consumers have enjoyed wider choice as well as being allowed to share some of the cost savings. The disinflationary impulse from globalisation has been a factor in keeping bond yields lower, which has been a contributory factor to higher equity valuations. What’s not to like?

Quite a lot it seems! It is now abundantly clear that there is a substantial minority of the developed world population that has suffered as their jobs have effectively been “exported”, mainly to emerging economies. Whole industries, notably in manufacturing sectors, have been hollowed out, although services have also seen substantial migration.
 
It should come as no surprise that US president Donald Trump is the key figure in this movement, but what you might not expect me to say is that there is some justification for his actions.
Thus certain politicians have gained support by advocating protectionist policies, not only to secure remaining jobs, but also to bring previously exported jobs home again. It should come as no surprise that US president Donald Trump is the key figure in this movement, but what you might not expect me to say is that there is some justification for his actions.

The biggest problem has been in his abrasive approach. He has been described as “the wrong answer to the right questions”. The social costs of globalisation for many western economies are becoming burdensome, and it is broadly agreed that China has not been playing fairly.
 
Even so, devils are often found in the detail, and one such detail is a proviso in the USMCA that neither Mexico nor Canada can forge a separate trade deal with a “non-market economy” – for which read “China” – without risking the breakdown of the USMCA.

A document released last week by the US outlining negotiating objectives ahead of a potential US/UK trade deal suggests that the UK would also be subject to such a stricture should it attempt to negotiate a separate trade deal with China in the supposedly unfettered post-Brexit world. This is a very clear message of the Trump administration’s long-term attitude towards China.

All in all, protectionism and nationalism has the capacity to cap, or even to reverse, many of the benefits of the last few decades, threatening a noxious combination of lower growth and potentially higher inflation as more grit is thrown into the gears of global commerce. And it’s not just big visible barriers such as tariffs.
 
Therefore it is understandable that equity investors will throw a party when a US/China deal is signed.
One can also include quotas, levies and sanctions as well as regulatory hurdles and safety standards, not to mention onerous customs paperwork. Therefore it is understandable that equity investors will throw a party when a US/China deal is signed, but it would be wise to be aware that the underlying tension between the US and China will remain.

There is also the small matter of an outstanding US investigation into European (mainly German) car exports. The US has frequently accused Europe (again mainly Germany) of not pulling its weight in terms of its share of global demand and military spending, for example. What better stick to beat it with than the threat of 25% tariffs on cars? Apparently a report (S232) has already been delivered to the White House recommending such action.

25%
Threat of 25% tariffs on cars
It won’t have escaped your attention that I have avoided the “B” topic again, but next week I will probably be forced to embrace it as we head into what could be a crucial two days of votes in Parliament. There again, a week can be a long time in politics.

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