It is hard to say with certainty what drives trading on any particular day, but it doesn’t seem a stretch to say that over the past few months a combination of tariffs and Federal Reserve rate hike fears have broadly impacted both equity and fixed income markets. However, while one could say that these two fears have impacted the relative returns of various markets, their actual impact on economic growth in our estimation remains negligible at most.
Trade Fears Narrow
Indeed, as our Q2 2018 Market Commentary detailed, the second quarter ended and the third quarter began with trade uncertainty running high but economic growth remaining robust. While our overall description of the U.S. economy has been upgraded to that of “Goldilocks” (robust economic growth but moderating inflation), we believe that overall trade policy has lessened as we enter the final quarter of 2018. This comment came to a head on the last day of the third quarter when the U.S., Mexico and Canada announced the successful conclusion to a framework for moving forward with the North American Free Trade Agreement (NAFTA)’s replacement, the United States–Mexico–Canada Agreement, or USMCA.
This is a very important development with regard to overall economic and market risk. We have moved from a broad worry that was based upon a global trade war that engaged many countries to one that is gradually narrowing to a spat between the U.S. and China. In other words, Canada and Mexico are the second and third largest U.S. trading partners with total 2017 trade (imports and exports) of $535 and $520 billion, respectively. Importantly, we also note that the U.S. and its sixth largest trade partner, South Korea, have agreed to a new trade deal. And during the third quarter, the U.S. and its fourth and fifth largest trading partners, the eurozone and Japan, agreed on basic frameworks that will set the tone for future trade negotiations.
While there will be future short-term back-and-forths that will drive daily trading, we continue to operate within our intermediate-term framework that these tariffs are not large enough to sink economic growth, and that negotiated paths forward will occur.