US trade policy and the Italian election
For those of you who thought President Trump’s populist ‘America First’ protectionist tendencies had faded into the background following the election – think again.
Proposed tariffs on US steel imports of 25% and 10% on aluminium are bad news. To be fair, the impact on US growth and inflation will be small. This is because steel and aluminium are only around 2% of US goods imports and 1% of US GDP. But you can look at any single restrictive trade action and argue its impact will be relatively small. What is of more concern, is the economic consequences of a trend towards more restrictions, and their cumulative impact on trade and economic activity more generally.
The immediate focus now shifts to possible retaliatory action. For steel – the European Union (as a trading bloc), Canada and Brazil will be the worst affected given a high percentage of steel imports originate from these countries. For aluminium imports, Canada has a dominating share. Indeed, the howls of discontent have been strongest from Europe and Canada.
There is unlikely to be a ‘tough’ response from China. While Chinese overproduction of steel has impacted globally, China is hardly affected by these tariffs. Only 1.6% of China’s steel exports and 16% of its aluminium exports go to the US (collectively accounting for 0.03% of GDP). That said, China is unlikely to sit idly by if further trade restrictions are announced.
This action is coming at a bad time in the cycle. The US economy is already at full employment, the economy is growing faster than potential, fiscal policy is being eased and the US Federal Reserve is already hiking interest rates. The last thing the US needs now is protection of inefficient industry that precludes the movement of labour and capital to more productive enterprises.
While generally Trump has moderated his protectionist ‘America First’ stance since coming into office, these latest moves seem to signal the start of more US trade restrictions (Chinese intellectual property has been spoken about lately and would have a much larger negative impact), which is not a good sign and will take away the positives to growth and equity market performance from the latest changes to US tax policy. While a full-blown trade war is unlikely to erupt in the near-term, talks about tariffs and trade restrictions will just add to market jitters and investor unease.
The Italian election was less about imminent risk of a Eurozone break-up but more about political stability (or lack thereof) and the degree of fiscal profligacy and winding back of recent reform (pensions, labour market) that would ensue.
We think of Italy as the weakest link in Europe. High debt, under-capitalised banks, high unemployment and poor productivity borne largely of labour market inflexibility are key features of Europe’s third largest economy. As the Italian economy improved as part of the cyclical recovery across the continent, the key anti-establishment protagonists softened the line on departure from the Eurozone but moved into a fiscal bidding war supplemented by promises to wind back the already inadequate attempts at structural reform.
The election outcome was a bigger blow to the establishment parties than generally expected. None of the major blocs of the left, the right, nor the Five Star Movement have sufficient share of the vote to form a government. Some form of coalition will need to be cobbled together and that will take time. But given the poor showing of the establishment parties, the pre-election speculation of a grand coalition is gone. More likely is some form of ‘government of national unity’. A fresh election can’t be ruled out, but this won’t happen immediately.
While an Italian exit from the Eurozone is unlikely, at least for now, it won’t be smooth sailing for the new Government. Whatever coalition configuration emerges it will not want to risk the fragile economic pick-up, especially with an unemployment rate still at 10.8%.
But it seems likely that as the new Government looks to meet its pre-election commitments, it will get push-back from Brussels, particularly on fiscal policy. In that respect, while we can park the risk of ‘Italexit’ for now, we wouldn’t be surprised to see the chatter re-emerge at some point – most likely during the next economic downturn.
Thanks to Diana Mousina, Senior Economist in our Sydney office, for her contribution to this post.
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