29 March 2018
Thoughts from the Americas

Having recently spent two weeks visiting clients in the Americas we outline the main discussion points and client feedback

Trade wars & protectionism

President Trump is trying to cut the US trade deficit, particularly with China, but his success may be limited given huge tax cuts and rising wages are giving US consumers more money to spend. Much of the increase in cashflow is being used to buy imported consumer goods, so getting a smaller deficit is going to be challenging. The fact so many countries have since been excluded from the US tariffs shows a willingness to do deals to avoid trade wars while there was growing optimism in Mexico that NAFTA will survive with Mexico willing to offer concessions to Trump. China reportedly offering to talk also gives some hope that the situation will calm. The fact that the Republicans lost the Pennsylvania House seat, despite it being a steel area, suggests a level of ineffectiveness of the protectionist policy with the electorate as we look towards the mid-terms in November. Clients broadly felt the protectionist rhetoric was more bark than bite and that things will calm down.

Trade Wars: Episode 1 - The Presidential Menace

Four scenarios for how trade wars could unfold and how costly a global trade war would be for major economies - as well as the implications for the US dollar and global risk sentiment

Key Messages

  • For global market dynamics to transition from what we see as currently being a Cold Trade Conflict to a real Global Trade War, we need to see one of two things: (1) a broadening of current US protectionist measures to other countries/sectors or (2) the US administration reacting to any initial retaliatory tariffs from Beijing.
  • Were an All-Out Trade War to break out, we estimate that the US will lose out most (-2.0% of GDP cumulatively over two years) – as US exporters would face higher tariffs at all borders, while the rest of the world continues trading with each other at prevailing trading arrangements.
  • It is the signalling channel of US trade policy that has typically been the key driver for the USD in prior ‘trade war’ episodes. Protectionist measures implicitly signal the US administration's desire for a weaker USD – and such expectations are likely to be entrenched in FX markets until credibly broken
French public deficit below 3% for the first time in ten years

French public deficit was 2.6% of GDP in 2017 - the lowest it has been since 2007. The budget has mainly been helped by the economic recovery in 2017 but fiscal measures should bring the deficit closer to 3% of GDP again in 2018

Higher growth and low interest rates are good for debt stabilisation

The French economy grew twice as fast in 2017 when compared to 2016 in real terms (and even more in nominal terms) which is used to calculate debt in percentage of GDP. 

This helped tax receipts to increase by four percent in 2017 while expenditures (outside debt service) increased by 2.7%. This divergence slashed the primary deficit (spread between receipts and expenditures) from 30 to 15 billion euros or 0.7% of GDP. With debt service declining thanks to the low-interest rate environment by 3.7% on the year (to 44.4 billion euros or 1.9% of GDP), the total budget deficit was limited to 2.6% of GDP. Therefore, the increase in total debt was also limited, to 0.4pp of GDP at 97%.

It was expected that the total budget deficit would end up below the 3% GDP threshold in 2017, but such a reduction in the primary surplus was not expected and its possible, it may not last either. 

Indeed, as the Government decides to transform the CICE tax credit in structural charge reduction, it should affect expenditures as a percentage of GDP as of this year. The European Commission currently believes it will push the deficit beyond 3% of GDP again. 

Given that the growth prospects are currently better (we expect 2.2% GDP growth for France this year) and that debt service should continue to decline this year, we think that the deficit could still be limited to 2.8% of GDP in 2018. 

For 2019, we believe that it will stabilise below that level, allowing the gross public debt to stabilise as a percentage of GDP. Therefore we don't believe that the French debt will reach 100% of GDP before 2020.

Italian election puzzle: tentative progress in the making

A Five Star Movement and Centre-right ticket now seem the obvious starting point for the government formation guessing game. Putting it in place will require a strong willingness to compromise on both camps. Easier said than done

PM Gentiloni remains the caretaker for now

The election of the presidents of the two houses of the Italian parliament turned out smoother than feared. After some inconclusive votes on Friday, when all parties were still testing ground, the solution to the puzzle was found overnight, with an agreement between the Five Star Movement (5SM) and the Centre-right coalition. 

In our view, the road to a future government is far from smooth. Passing the European 'test' won't be easy

When the voting process resumed on Saturday, it was soon apparent that the parties involved in the agreement will stick to their word. In a couple of rounds, Roberto Fico, a top representative of the left-hand of the 5SM, was elected as the new president of the House of Deputies, supported by its party and by the whole centre-right. PD’s MPs continued supporting their candidate, instead. The same agreement made Elisabetta Casellati, a long-term Forza Italia lawmaker the speaker of the Senate.

After the election of the two presidents, the outgoing PM Paolo Gentiloni submitted his resignation to President Mattarella, who asked him to remain as a caretaker for the time being.

Reading time around 5 minutes

In Case You Missed it: One year to go

One year to go until Britain leaves the EU, Italy's populist parties edge closer to forming a government and we highlight the investment proposition offered by Central and Eastern Europe. Here's our thinking 

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