Stocks give Trump a US$1.3t reason to escalate trade war

A trader works on the floor of the New York Stock Exchange as US President Donald Trump speaks on television July 27, 2018. — Reuters pic
A trader works on the floor of the New York Stock Exchange as US President Donald Trump speaks on television July 27, 2018. — Reuters pic

NEW YORK, Aug 8 — It turns out that a trade war isn’t enough to tarnish President Donald Trump’s favoured report card: The American .

The S&P 500 Index logged back-to-back gains the past two sessions that pushed the benchmark close to its record, despite ’s unveiling of tariff plans on Friday. The gauge was less than half a per cent from the all-time high yesterday.

With the S&P 500 climbing by some US$1.3 trillion since Trump unofficially kicked off the trade war by announcing aluminum and steel tariffs on March 1, he has all the more reason to escalate the trade battle between the world’s two largest .

Beijing’s recent retaliation failed to spur any whiff of risk aversion when it came to U.S. stocks, unlike previous rounds of tariff threats between the nations. While China’s Shanghai Composite Index is down nearly 16 percent year-to-date, helping spur its policy makers to cushion their economy, there’s little market-driven incentive for Trump to take action.

The danger, though, is that American equities are caught in a so-called Minsky Paradox. Srinivas Thiruvadanthai, research director at the Jerome Levy Forecasting Center in Mt Kisco, New York, mused about that earlier this year. The logic dictates that unless the market sells off, the president would feel confident in pushing forward with his trade offensive — in turn raising the risk of an even bigger slide.

Minsky Paradox

“Over a period of apparently stable behaviour the underlying financial conditions evolve so that the likelihood of instability increases,” the economist Hyman Minksy wrote in 1986.

“Trump’s negotiating stance has clearly been emboldened by the resilient markets,” said Michael Collins, a senior portfolio manager at PGIM Inc, on Bloomberg TV.

The president himself validated that assessment last month, saying “this is the time” to confront China, noting that stocks were well up since he took office. “We’re playing with the bank’s money,” he said in a CNBC interview. Even so, equities could have seen double the gains without the trade campaign, he said.

With US stocks “bullet-proof for now” in light of robust earnings growth, fixed income could be the asset class to deliver a rebuke on the administration’s policies, according to Thiruvadanthai.

“The vigilante coming in would be more likely than the equity vigilante,” he said. “The impact of trade wars on the global economy is too far out to see to price in easily, whereas the market is looking more at .”

Tariff hikes could drive prices up, in turn spurring investors to demand a bigger term premium — the extra compensation investors demand to hold longer-term debt over shorter-term securities. The premium has been languishing at historically low levels.

A substantial rise in the premium would affect corporate-financing decisions as well as the discount rate on future earnings for US equities — potentially serving as a potent financial shock, said Karthik Sankaran, director of global strategy at Eurasia Group in New York.

Yet there’s little sign investors are worried about prices spiraling higher at this juncture. In fact, market-implied measures of inflation compensation are running below levels consistent with the Federal Reserve’s target of 2 per cent inflation.

That gives more time for the potentially untenable equilibrium between US markets and trade policy to endure.

“We might get prices going up here and there, but by and large, people are not going to get upset, as things will be okay for now,” said Thiruvadanthai. “That gives Trump latitude to ratchet up the pressure before his voters feel the impact.” — Bloomberg

Source: The Malay Mail Online

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