Perspectives - Are we out of the woods?

There have been a series of recent events regarding the tariff wars which have led markets in the US to rally back to their Liberation Day levels, while several international equity markets have been making new highs. Equity markets have digested the near term risk of the tariff strategy and are starting to believe that the impact on companies is less severe than at first feared.

Perhaps it was all a storm in a teacup. While it is hard not to think that there will not be a certain amount of supply chain disruption, delays to capital investment decisions and hiring plans, aggregate assessments of the impact on the economy appear to be manageable. At the same time statements during the earnings season suggest companies are not as worried as we might have expected.

That said, we only have a delay and interim reductions in China tariffs to hang the optimism on, so there is plenty of room for further bumps on this journey.

We have been using a framework that the near-term outcomes are relatively unpredictable while the longer term intended direction is relatively clear. The US is trying to reset its fiscal and trading positions in its favour. This will involve both reduced supply and demand for US treasuries and hence, dollars in the longer term. If the rest of the world has a smaller surplus with the US, it has less need to recycle those surpluses in US capital markets. Therefore, the US is likely to attract a smaller percentage of the flow of global savings.

There are other legs to the current US’s economic policy which have been less talked about but are arguably at least as important. The bonfire of the agencies, seen as largely a cost cutting exercise, is as much an attempt to liberate US business from regulation. The Federal budget may be reduced somewhat from this action, but the much greater impact will be on the expenses and dynamism of the US economy. Whatever the rights and wrongs, we in the heavily regulated economies of Europe may think of deregulating such areas as environmental protection, there is clearly an economic cost to pay for a heavy regulatory burden.

The other massively important change is banking deregulation. Too esoteric to go into in great detail here, there are two intended impacts. One is to encourage small and medium sized banks to grow their loan books. The other is to create an incentive for banks to hold more treasuries, replacing the reduced international buying. Unlike the Chinese economy, authorities are not able to just demand banks lend to certain sectors, the US must create economic incentives for banks. Since the GFC the direction of travel has been in the opposite direction. Once enacted there will be a greater incentive to lend and to hold treasuries, in a break from the current international banking consensus.

At the same time, weak oil prices and recently announced moves to reduce pharmaceutical costs, will be putting downward pressure on inflation, possibly giving the opportunity to cut interest rates.

These changes are arguably much more favourable for small and mid-sized companies rather than the largest. The burden of regulation falls most heavily on small businesses in most industries. Smaller companies are also much more dependent on bank financing rather than equity markets. The medium-term outlook for the US economy arguably remains positive and improving.

We would argue that the long-term impact of the planned reset will be most positive for those financial markets which will attract the savings flows directed away from the US, such as Europe and Emerging markets. There is however, an emerging argument for a major revival in domestic US performance and hence a relative recovery in US mid-cap stocks.

David Jane

Premier Miton Macro Thematic Multi Asset Team