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The implications of lighter fluid and the Powell put

Peter Warnes  |  23 Feb 2018Text size  Decrease  Increase  |  
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Donald Trump wants the US economy to grow at an annual rate of 6 per cent, driven by an unbridled, debt-fuelled, politically-devised fiscal policy, regardless of the consequences. 

Even Goldman Sachs chairman and CEO Lloyd Blankfein sees the danger of "throwing lighter fluid on the fire that is already going," dangers ex-Goldman employees Mnuchin and Cohn can't or don't want to see. I agree with Blankfein, but think he should have used the words "high-octane accelerant," rather than lighter fluid.

High-octane to describe the $1.5-trillion tax package and the $1.4-trillion infrastructure package to add to an already stretched US budget deficit. In 2017, the US government borrowed US$519 billion. It is on track to borrow almost US$1 trillion in 2018 and Treasury forecasts borrowing over US$1 trillion in 2019 and over US$1.2 trillion in 2020.

There is likely to be meaningful inflationary consequences given the tightness in the jobs market and capacity utilisation limits starting to be stretched. A weak currency will lift import prices, which has the potential to expand an already significant trade deficit.

The director of the White House National Economic Council, Gary Cohn, has dismissed inflation fears--"we are not worried about overheating the economy. We know how to deal with inflation. We don't know how to deal with deflation." The US would probably win a nuclear conflict, but that is not a good reason to start one.

Trade policy turns more aggressive

While the White House is driving US fiscal policy, it is also the force behind the more aggressive trade policy. This falls in line with the President's "America First" dogma aimed at protecting domestic manufacturers and jobs. The Trump administration wants to significantly reduce or even eliminate the trade deficit.

The deficit widened by 12.1 per cent in 2017 to US$566 billion, the highest since 2008. The gap with China increased by 8.1 per cent to a record US$375.2 billion or 66 per cent of the total and with Mexico US$71.1 billion, the second highest on record. The petroleum deficit was US$95.9 billion, the smallest since 2003, on record exports as shale production increases.

Clearly, to make serious inroads into the deficit, China must be the target. The proposed increased tariffs on steel and aluminium imports could add "lighter fluid" to an already tense environment. The Department of Commerce has given the green light for a punitive increase of 24 per cent on imports of steel and a lesser 7.7 per cent on aluminium.

The increases were recommended on "national security" grounds. This is seen as a "loophole" facilitating protectionism and has not gone down well with trade partners. President Trump now has 90 days from 16 February to review the proposals and decide on an appropriate course of action. Given his repeated promises he would protect the US steel industry it is likely he will back the proposals.

The proposals were developed to ensure 80 per cent capacity utilisation in the steel and aluminium industries. US companies consuming high volumes of steel and aluminium will object as input costs rise and exporters will object that the unilateral action breaches international trade obligations as established under the World Trade Organisation.

A trade war could erupt with few if any winners. In recent years, US steel companies have been doing very well without increased tariffs or quotas.

Could the Powell put become a reality?

Over the past six or so years global equity markets have benefited from the most accommodative monetary policy in history. In the aftermath of the GFC, the US Federal Reserve (the Fed) ensured the US financial system was re-liquefied. Where necessary, other central banks followed.

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Peter Warnes is Morningstar's head of equities research. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

 


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© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written content of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is Morningstar's head of equities research.

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

© 2020 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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