24 August 2018
South Africa: Trump’s unwelcome attention

President Trump’s foreign policy tirade has turned in a surprising new direction: South Africa. His concerns over threatened land expropriations from farmers are raising fears of fresh US sanctions. This is more a risk for the rand than the sovereign since a large part of South Africa's external debt has been issued in local currency

Trump tweet hits the rand

The ZAR briefly sold off Thursday on news that Donald Trump had tasked Mike Pompeo, the US Secretary of State, to ‘closely study’ the issue of land expropriation from farmers in South Africa. With US foreign and economic policy merging into one this year, investors have naturally started to worry about whether Washington could look at the economic sanctions tool to effect change.

For reference, South Africa’s ruling ANC party is currently examining ways to amend the constitution to potentially expropriate farmland without compensation. A parliamentary review committee will come back with an opinion on this issue by the end of August.

Trade war: China retaliates but with a punchier list

China’s decision to include automobiles in the retaliatory tariffs list is a more aggressive move than we expected, but for now the real concern is what the ‘qualitatively measures’  will be if the US imposes 25% tariffs on $200 billion of goods

 As the US imposes 25% tariff on $16 billion of imported goods from China, China retaliated with the same amount but with a revised list of goods that contains automobiles, which we see as a more aggressive retaliatory measure.

Qualitative retaliations could include placing administrative measures on US companies operating in China or following the US lead and leveraging 'national security' to prevent American companies operating in the country

The $16 billion revised tariff list from China includes medical equipment and automobiles when the US administration would like to help American automobiles fare better in the international market. We see this list as more punchy than the previous one even the amount involved stays the same at $16 billion. 

The dollar index has reacted in strengthening trend and the yuan weakened against the dollar.

Making trade ‘fair’ won’t do the trick for Trump

Tariff wars don’t address the real drivers of the US trade deficit, and US policy is on track to increase, rather than decrease the US trade deficit. In any case, a smaller trade deficit may be the last thing that US voters really want

Deficit drivers

The US trade deficit is sometimes used as proof by President Trump that the US is treated unfairly by its trade partners. This is a popular – perhaps even election-winning – position. Presidential approval ratings on the economy have improved in 2018 alongside the escalating trade war. In practice, the US is not more open than other advanced economies. Around half of the US trade deficit, which was 3% of GDP in the latest data, is accounted for by trade with China. Germany, Japan and Mexico make up a further quarter. But these surplus countries don’t fit a particular profile in terms of openness. China is less open than the US, in terms of tariffs and non-tariff barriers. Mexico is in a free trade agreement with the US, meaning there is no difference between the tariffs of the two countries. Germany and Japan have similar tariffs to the US, and are more open in their treatment of foreign suppliers.

The US’s official position on trade imbalances covers a broader set of factors than fit in a tweet, but also basically lays the blame for the US’s trade deficit at the feet of other countries. Along with trade and investment barriers, it highlights major trading partners’ slower domestic demand growth, and undervalued currencies. Separately, it has been suggested that relatively high barriers to trade in services have made it more difficult for countries which have specialised in services – such as the US - to export them. New IMF research shows reductions in the costs of exporting are associated with improvements in current account balances (made up of the trade balance and net income and transfers from abroad). However, the fundamental driver of the US current account deficit is the level of saving and investment in the US economy. Over many years, foreign capital has been readily available to fund investment at a level that could not have been sustained by US domestic savings. The dollar’s role as a global reserve currency plays a part in attracting these inflows, as does the level of savings in other countries.

In its 2018 assessment of external imbalances, the IMF highlights that fiscal easing in the US is leading to a stronger US dollar and increase in the current account deficit in the coming years. We would add that the effects of the dollar’s appreciation during 2014-17 are still likely to be passing through to the current account, and the government and households both seem unlikely to increase savings. The IMF and the Trump administration agree on one thing: that the US should reduce its current account deficit. But the IMF’s policy prescription of fiscal consolidation, encouraging household saving, and resolving trade disagreements without raising tariffs and non-tariff barriers, is the opposite of what the US is doing. (The IMF also highlights the role of co-operation between countries to address global imbalances, with an onus on surplus countries to loosen fiscal policy).

Nafta talks progress but sticking points remain

A 'handshake' deal between the US and Mexico is reportedly within touching distance, raising the possibility that Canada could rejoin talks. But several key sticking points remain and it's unlikely we'll see a full de-escalation in trade tensions before the US mid-term elections

A handshake is all it takes

With the possibility that a ‘handshake’ deal between the US and Mexico could come as soon as today, the likelihood that Canada will rejoin the negotiations soon is rising. 

After five weeks of discussions, the US and Mexico have reportedly come close to an informal deal on some of their main issues - namely automotive rules, and in particular how much of a car must be sourced in North America to qualify for reduced Nafta tariffs. Industry expectations are that North American car content may rise to 70%, up from 62.5% to make the tariff cut, and reports suggest that somewhere around 40% of this value must come from a source paying at least $16 per hour – which isn’t bad news for Canada.

Swedish elections: Muddy waters

Swedes go to the polls on 9 September. The election result looks likely to be messy. While Sweden’s economic fundamentals and institutions are solid, we think political uncertainty could add some volatility to the exchange rate in the near term

A stable foundation

Swedish elections are usually fairly staid affairs and historically, have not been all that interesting from a market perspective. When it comes to economic policy, the differences between the mainstream centre-left and centre-right political blocks in Sweden are arguably not all that significant. The centre-left tends to favour welfare spending when in power while the centre-right is more likely to pursue tax-cuts, but both are committed to a sound budget underpinned by a fiscal rule.

Fiscal policy is constrained by a requirement to run a structural surplus of 0.33% of GDP over the economic cycle and keep government debt anchored around 35% of GDP. In practice, this means there is limited scope for any government to pursue radically different fiscal policies. And key long-term decisions (e.g. pension reform) have historically been agreed by consensus among the major parties.

Sweden: How long can the good times last?

The Swedish economy has held up surprisingly well in the first half of 2018. We still think a slowdown is coming though

Growth has remained strong

For some time now, we and most other forecasters have been expecting the Swedish economy to slow down. After several years of strong growth, driven in large part by a booming housing market and strong consumer demand, the Swedish economy seems unlikely to sustain 3%+ annual growth in output. Long-term potential growth is more like 2% per year.

But so far this year, expectations for a slowdown have proven unfounded. GDP grew strongly in both 1Q and 2Q, with output up 3.3% compared to the middle of 2017. The housing slowdown has yet to make a major impact on growth figures. While new housing construction slowed markedly in 2Q, an increase in other investments offset this. And consumer spending, which is typically sensitive to house prices, has held up despite the sharp fall in house prices at the end of 2017.

Expect more voter volatility ahead of Brazil’s presidential election

Latest opinion polls suggest Brazilian voter intentions have been remarkably steady in recent months. That could change given the high level of undecided voters, the start of TV ad campaigns and a court decision regarding the candidacy of the jailed former president 'Lula'

Alckmin has secured his position as a competitive candidate

The biggest change in local market sentiment towards the Brazilian election over the past month has been a more constructive assessment regarding the ability of the establishment candidate, Geraldo Alckmin, to win the race, following the consolidation of a broad party alliance network. 

Alckmin was indeed the biggest winner of the party negotiations

Alckmin was indeed the biggest winner of the party negotiations, followed by the jailed former president, Luiz Inácio 'Lula' da Silva's PT party, which was able to unify part of the left with the withdrawal of Manuela D’Ávila’s candidacy. Ciro Gomes was the biggest loser, as the candidate failed to seal any significant alliances, despite intense negotiations with both the left, which he lost to the PT, and the centre, which he lost to Alckmin. Marina Silva and Jair Bolsonaro seem more comfortable with their isolation, actively deploying it to solidify their status as outsider/anti-establishment candidates.

As a result of the negotiated party alliances, Alckmin’s campaign will amass 44% of the total airtime for presidential candidates in the state-sponsored TV/radio campaign that starts on August 31. The PT candidate will receive about 20% of the dedicated airtime, followed by Henrique Meirelles (15%) while the remaining candidates all get 5% or less, as we show in the chart below

Dethroning the King: Five ways Trump could weaken the dollar

Can President Trump instruct the US Treasury to intervene in FX markets and weaken the dollar? Twelve months ago, we wouldn't have even considered this question. But under this new mercantilist US regime, who knows? We identify five ways in which Washington could try to engineer a weaker dollar

Key messages: Time to consider how Trump could weaken the dollar

  • President Trump’s ramped up verbal jawboning in recent weeks suggests that current USD strength may be the upper bound of the White House's tolerance level
  • We identify five policies that the White House could employ to weaken the dollar: (1) US FX intervention and building out US FX reserves; (2) Changing the rules of the game for the Fed; (3) Ongoing jawboning and talking down the dollar; (4) Pressuring major trading partners to strengthen their currencies; (5) Creating a US sovereign wealth fund.
  • We don’t think any small-scale unilateral intervention by US authorities will have a sustained impact on weakening the dollar. The best historical precedent – the Bush FX interventions in 1989-1990 – shows that this approach had a limited impact in driving the USD materially lower.
  • Given that the current loose fiscal, tight monetary US policy mix is inconsistent with a weaker USD, we think that the US administration may find greater success by addressing one of the root causes of recent USD strength – higher US rates. Constant Fed criticism may keep a downside skew in US rates markets when it comes to pricing in Fed policy tightening – and on the margin, help to keep USD strength at bay.
  • In a normal market environment, we think Trump jawboning could weigh on the dollar via a clearout of speculative long USD positions, weakening the power of interest rate differentials in influencing USD crosses and reducing the incentive for overseas investors to take on unhedged USD exposure. If the short-term fundamental USD factors were to wane as well, then we think a clearout of long USD positioning could be worth a 5-7% decline in the trade-weighted USD index.
  • Alternative ways in which the Trump administration could weaken the US dollar – pressuring major trading partners to strengthen their currencies or even the creation of a US sovereign wealth fund – would be more slow-burning and medium-term in nature.
  • Overall, more active steps from the White House to weaken the dollar could serve to knock the top off of an emerging dollar bull trend. Indeed, such active steps send a strong signal about the White House’s current dollar policy. We think the US administration's implicit desire for a weaker USD that is consistent with its mercantilist US trade policy will inevitably be self-fulfilling over the medium-term – and is one of the reasons why we remain strategically bearish on the US dollar.
Reading time around 11 minutes

In case you missed it: De-throning the king

President Trump's tariff wars have produced an unintended consequence: a stronger US dollar. Is there anything he can do to stop the rally and is 'fair' trade even the answer to the US's burgeoning trade deficit? Meanwhile, as Nafta talks show signs of progress, Trump finds a new bugbear in South Africa. Here's how we think it'll all shake out

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