Izak Odendaal, Chief Investment Strategist at Old Mutual Wealth
To say that the last week was wild would be an understatement. We are only 18 days into the second Trump administration, with 1442 days still ahead of us. The week started with US President Donald Trump imposing hefty 25% import tariffs on Canada and Mexico and 10% tariffs on China. The market reaction was understandably negative. After talks between Trump and his Mexican and Canadian counterparts, the implementation of the tariffs was put on hold. Mexico City and Ottawa promised to better police their borders, a small price to pay to avert the potentially catastrophic impact on their respective economies. Both countries send around 80% of their exports to the US.
The tariffs on imports from China remain in place and will be added over and above those Trump imposed in his first term which were retained by Joe Biden. China retaliated with some tariffs of its own, but it has more to lose from a trade fight than the US does, so didn’t push things too far. For instance, it could easily allow the renminbi to weaken to offset the tariff impact, but doing so could further antagonise the US and send the wrong message internally, potentially leading to capital flight.
Trump also lashed out at South Africa, to the surprise of many who weren’t sure he even knew the country existed. His comments on the new Expropriation Act are completely misguided, since the constitutional protection of property rights remains unchanged, but could hurt sentiment towards South Africa. Other Trump associates also attacked the country’s black empowerment policies and perceived anti-American stance. Trump suspended American funding to South Africa, most of which goes for HIV/Aids treatment, but it should be noted that US aid and development funding to other countries has also been cut. Tragically so, since it is a small fraction of the overall US budget but makes a big difference in many poor countries.
The two Trumps
Complicating things for investors across the globe is that we don’t know (yet) which version of Trump we’re getting. Is it the ‘Art of the Deal’ or ‘Time to get Tough’ version, to quote the titles of two of the books he wrote (or rather, books that were ghost-written for him).
‘Art of Deal’ Trump was on full display last week. The tariffs were quickly put on hold when Mexico and Canada made very small concessions. As long as he can claim victory, it seems that friend or foe can strike a deal with him. This version of Trump will cause volatility and uncertainty, without necessarily changing much.
‘Time to Get Tough’ Trump might still wait in the wings. If he is serious about a fundamental reordering of the US economy and its relationship with the rest of the world – and some of his key advisers certainly are – it points to downside risk for global and US growth.
The US imports more than it exports and therefore runs a massive trade deficit. Trump and many of his advisers sees this as the US “subsidising” other countries that are taking advantage of the situation. While there might some truth in this view, it misses the bigger picture. The US deficit reflects the voracious consumer appetite of US households while also being the mirror image of the massive US capital account surplus. While the US buys goods from other countries, it sells them financial assets. To put it very simply, it imports iPhones but sells Apple shares to the rest of the world.
When the US put tariffs on China in 2018, imports from China dropped, but imports from other countries increased. The overall deficit continued growing relentlessly, in line with growth in consumer spending.
Chart 1: US trade balance
Source: LSEG Datastream
To reduce the overall trade deficit, US consumers will therefore have to spend less and save more, and foreigners will have to reduce purchases of US shares and bonds, a massive shift in the trends of the past few decades.
A weaker dollar would also help by discouraging imports of goods and foreign purchases of financial assets. Instead, the dollar is extremely strong. On a real trade weighted basis, the dollar has only been stronger 23 of the 647 months since it started floating freely in 1971.
At this stage, almost everyone will welcome a weaker dollar. It will make US firms more competitive and relieve pressure on other countries saddled with dollar-denominated debt.
Chart 2: Real trade weighted US dollar
Source: LSEG Datastream
The situation in China is the mirror image of the US: too much savings, too much reliance on exports, and not enough domestic consumption. In an ideal world, the two largest economies would agree on a joint rebalancing in opposite directions, as well as an appreciation of the renminbi against the dollar. Something similar happened between the US, Japan, Germany and others in the mid-1980s, the so-called Plaza Accord, the last time the dollar was this strong. Given the rising animosities between the US and China, this seems unlikely now.
Taking a longer-term view, there is also the distinct possibility that, rather than making America great, Trump could weaken its foundations. The US will always have the best geographic location in the world, protected by two vast oceans and blessed with a large population and rich endowment of natural resources. However, its wealth and power also stem from strong institutions, including courts, regulators and government agencies, while it benefited greatly from skilled and unskilled immigration throughout its history. The rule of law, central bank independence, top-notch domestic and foreign intelligence services, and a military machine at the cutting edge of technology and doctrine are all part of what makes the US the world’s most powerful nation. By hollowing out these institutions, and appointing lackeys in key positions, Trump risks undermining, not strengthening the US. This would ultimately do more damage to the dollar’s reserve currency status than any scheme Beijing or Moscow can cook up.
However, this is all in the realm of “what if?” and “what next?”. It is easy to get distracted by the cacophony and forget to also look at what is currently happening on the ground.
Here are three things to consider.
Firstly, Friday saw the monthly barrage of US employment data. Employment growth slowed more than expected, but the monthly payroll number has been volatile and noisy for a while now. The growth rate on a year-on-year basis remains in line with the longer-term average of 1.4%. This is a solid but unspectacular rate of employment growth and supports household incomes, especially since various measures of wage growth are around 4% year-on-year, comfortably ahead of inflation. Real income growth supports consumer spending, which means there is little near-term risk of a US recession. A US recession is the worst-case outcome for investors in risk assets anywhere in the world. Trump may cause volatility, but a recession will cause a bear market.
Secondly, central banks are still going about their business. The US Federal Reserve seems on pause for the foreseeable future. Even before the Trump fireworks, sticky inflation, strong income growth and low unemployment (4%) meant the case for further rate cuts was getting thin. The uncertainty around tariffs, immigration and other elements of the new administration’s economic policy supports a “wait and see” approach. Tariffs will push up prices, though how much depends on many factors. The Fed will look through the first-round impact of such price increases and focus on the second-round effects, namely whether the prices of non-tariffed goods rise in sympathy, selling prices rise due to higher input costs and workers demand higher wages to compensate for higher prices. At any rate, imported goods make up a small portion of the overall US inflation basket which is heavily skewed to services.
Chart 3: US 10-year bond yield
Source: LSEG Datastream
For now, nothing suggests that the Fed will have to start hiking rates, which would be the other cause of a major global market meltdown.
In fact, US long bond yields have declined in recent weeks, and remain range bound. This suggests the market is not expecting higher rates and might even be adjusting the rates outlook lower a bit. This is welcome, since much higher yields would be a worrying signal while also raising borrowing costs for companies and households. As much as the Fed steals the limelight, a large portion of borrowers have loans linked to bond yields. This is particularly true of mortgage rates. When the Fed hiked rates, most US homeowners were unaffected, since they had fixed-rate mortgages, and could lock in the low pre-2022 borrowing costs. But it also means there is less of a boost now when the Fed reduced its policy rate.
In Europe, central banks are cutting, despite the inflation risks that come from weaker currencies. The European Central Bank, Swedish Riksbank and Bank of England cut rates over the past two weeks. Eventually, these rates will have a stimulative effect. Already Eurozone and UK equities have jumped to near-record levels. The floating rate loans that hurt so much when rates were rising will provide more immediate relief than in the US.
Chart 4: Central bank policy interest rates
Source: LSEG Datastream
SONA scan
Thirdly, despite the negative light now shining on South Africa, it is unlikely to derail the improvements that are taking place here. It is vital that the country remains on good terms with the US, a very important trading partner and major source of foreign direct investment. At most immediate risk would be duty-free access to the American market under AGOA, which covers around a third of South Africa’s exports to the US. President Ramaphosa’s State of the Nation Address (SONA) tried to balance asserting South Africa’s sovereignty while also holding out an olive branch to the US.
But the events of the past week should also reinforce how urgent it is that the country gets its own house in order amid an increasingly uncertain global environment. It was notable, therefore, that the bulk of SONA was dedicated to growing the economy and improving public services. It also appears that tensions within the government of national unity (GNU) that emerged in recent weeks have reduced and that compromises were reached, notably on the touchy issue of National Health Insurance.
The country is good at making plans and bad at implementing them, so scepticism is warranted. What is different about SONA 2025 is the consistent theme of creating space for the private sector to get involved in network industries and infrastructure spending. The growth of the economy will not depend on clever plans drafted by government bureaucrats, but from crowding in the private sector and unleashing the power of entrepreneurship at all levels of society, especially in townships and rural areas. This requires more effective support from government, but also government getting out of the way – less government, and more governance.
This is especially true of local government, which remains dysfunctional in many parts of the country. The president highlighted important initiatives to improve the operational and financial health of municipalities. Many of these are still in the early stages of implementation and will take years to bear fruit. Every long journey starts with the first step, however.
In summary, the global picture still presents more questions than answers at this stage, but there are developments on the ground we can track, even though predicting political twists and turns are near impossible. Locally, there is real progress underway, but there will be setbacks too, including the possible headwinds of global trade wars. It may sound tired, but it has never more true that diversification is crucial. We cannot know what will happen a day or a week from now, never mind two or five years. But we can position our portfolios with a sensible mix of growth and income assets, local and global, to manage risks and benefit from opportunities. Patience will probably be even more important than always and also finding a way to tune out the news (and the noise). Despite the wild week we had, the rand ended stronger and JSE higher. News headlines are not useful portfolio management tools.
ENDS
