by Brad Tank, CIO, Fixed Income, Neuberger Berman
Do not allow trade-talk noise to distract from the rates and inflation signals.
Two days after President Donald Trumpās inauguration I wrote about sorting the signal from the noiseāthe importance of taking a long-term perspective, being mindful of historical context, focusing on the real facts and sticking to them in your decision-making.
āOf all the objectives in the new administrationās agenda,ā I wrote at the time, ānone is likely to have more impact on markets and the valuation of individual stocks and bonds than reforming the tax code.ā
While the noise level was high last year, the administrationās prioritiesācutting regulation and business taxesāhave been settled Republican policy objectives since at least the Reagan era. This yearās prioritiesācutting immigration and intervening on tradeāare not mainstream Republican at all. They cut across party lines, cause controversy domestically as well as internationally, and make the historical playbook irrelevant. Throw it out.
Get Used to Trade Being Front-Page News
Trade is far more complex than tax, from a policy standpoint, and certainly less well understood. The markets are further challenged by an absence of recent relevant experience to draw upon. In my 36 years in the markets, trade has rarely captured the headlines for long. The Plaza Accord in 1985, the creation of the World Trade Organization in 1995 and Chinaās admission into the WTO in 2001 are the few times that stick in my memory. Itās only thanks to the recent noise that we now recall the Bush administrationās short-lived steel tariffs in 2002, otherwise forgotten. Still, everyone knows the big lesson. In the spirit of the times, Iāve suggested to my family that we rename our Labradors Smoot and Hawley, after the U.S. Senator and Representative who sponsored the ruinous Tariff Act of 1930. Itās not going to happen.
When Joe Amato tackled the subject last week, he pointed out that the tough talk on trade would likely remain, uncharacteristically, on the front pages for at least the rest of 2018. Does this mean it will be the primary driver of market outcomes?
In the short term, this seems unlikely. We are talking about $50 billion to $60 billion worth of goods traded between two countries. That amounts to about a tenth of the value that these two countries trade each year, and a drop in the oceans of U.S. GDP, at $19 trillion, or world trade in manufactured goods, at $16 trillion. One would like to believe that the lessons of the 1930s mean that negotiations will prevail before this escalates enough to hurt the confidence of business people making hiring and investment decisions. In that case, U.S. tax reform is a much bigger deal for them than tariffs on pork and steel.
Signals Behind the Noise
It is all too easy to start screening the true signals out, however, precisely because they are so important, or because we think we already understand them. My suggestion is to keep reminding yourself that the Fed is already tightening and the ECB is likely to follow before the year is overāand just how monumental those facts are, after years of zero-interest-rate policy.
Can risks to trade generate enough uncertainty to slow policy tightening? FOMC members suggest they can, but they still think there are much stronger forces affecting inflation expectations, such as the coming fiscal stimulus and rising wages.
Are the marketās short-term perturbations in response to trade rhetoric overdone, then? At this point it is probably too early to say. The marketās view of this administrationās approach to trade negotiations is best summed up by Topper Harley, hero of the cult comedy classic Hot Shots! movies: āIām not saying I donāt trust you, and Iām not saying I do. But I donāt.ā
Trust will have to develop over time. It is not around the corner. In the meantime, get used to a lot of noise. And try to keep focused on the more important signals: those coming from the Fed and the ECB.
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