THE DAILY EDGE: 22 JANUARY 2020

The Chemical Activity Barometer (CAB), a leading economic indicator created by the American Chemistry Council (ACC), jumped 0.6 percent in January on a three-month moving average (3MMA) basis following a 0.1 percent gain in December. On a year-over-year (Y/Y) basis, the barometer rose 1.4 percent.

The unadjusted January data showed a 1.0 percent gain following a 0.5 percent increase in December and a 0.4 percent gain in November. The diffusion index rose to 62 percent in January. (…)

The CAB is a leading economic indicator derived from a composite index of chemical industry activity. Due to its early position in the supply chain, chemical industry activity has been found to consistently lead the U.S. economy’s business cycle, and this barometer can be used to determine turning points and likely trends in the broader economy.

PWC’s Global CEO Survey: Navigating the rising tide of uncertainty

What a difference two years can make. In 2018, PwC’s Annual Global CEO Survey revealed a record level of optimism regarding worldwide economic growth. This year, as CEOs look ahead to 2020, we see a record level of pessimism.

For the first time, more than half of the CEOs
we surveyed believe the rate of global GDP growth will decline. This caution has translated into CEOs’ low confidence in their own organisation’s outlook. Only 27% of CEOs are ‘very confident’ in their prospects for revenue growth in 2020, a low level not seen since 2009. This finding is compelling because the change
in CEOs’ revenue confidence has proven to
be a reliable indicator of both the direction
and the level of global GDP growth in the year ahead, according to our analysis. (…)

When we performed a detailed statistical analysis of survey responses dating back to 2008, we found that CEO attitudes are quite accurate in anticipating both the direction and the strength of the global economy. Specifically, the change in their confidence regarding their own organisation’s revenue growth prospects in the year ahead correlates strongly with actual global economic growth. (…) Indeed, CEO revenue confidence can be said to be a leading indicator of global economic growth. Using this analysis, we estimate from this year’s survey responses that global growth could slow to 2.4% in 2020
— well below the October 2019 IMF forecast
of 3.4%. (…)

The percentage of CEOs citing a decline in the rate of growth exceeds 50% in all but two regions: Asia-Pacific and CEE. Nowhere has the swing been more pronounced than in North America, where a record 63% of chief executives believe the global growth rate will decline. Two years ago, the same record share of North America CEOs (63%) said the opposite, that the global economy would improve (buoyed in the US by the fiscal stimulus of the Tax Cuts and Jobs Act). (…)

IMF Predicts Global Economy Will Rebound in 2020 The IMF expects global gross domestic product will expand by 3.3% in 2020, up from 2.9% in 2019.

The improved outlook is driven by a combination of aggressive monetary policy easing in 2019 and detente in America’s nearly two-year trade war with China. (…) The IMF expects (…) trade volumes rising 2.9% in 2020. (…)

The IMF characterized the signs of stabilization as “tentative,” saying that renewed trade tensions could “undermine the nascent bottoming out of global manufacturing and trade, leading global growth to fall short of the baseline.” (…)

The IMF forecasts that both the Chinese and American economies will slow in 2020. They expect the U.S. to grow 2% in 2020, down from 2.3% in 2019. China’s rate will slip to 6% in 2020 from 6.1% in 2019. (…)

Brazil, India, Mexico, and Russia are expected to see growth accelerate in 2020, by about a full percentage point in each country. (…)

US-China deal won’t pull world trade out of the doldrums

(…) I don’t have high hopes that these effects will be significant, not least because the trade war barriers aren’t being lifted by much; the American tariff increases stay in place for the most part. 

Another reason for caution is that  a significant part of the tariff increases only came about during the course of 2019. This means that trade flows in the first part of 2020 run up against higher trade barriers than last year, a drag for world trade,

As for China’s commitment to import an extra $200 billion of US goods, of which there should be some $76bn this year, one should realise that a share of these imports will come at the expense of Chinese imports from other countries. 

Together, the positive impulses from the deal on US-China trade and the negative impulse from earlier tariff increases feeding into 2020 deliver a boost to world trade of – at best – $20bn, only a growth of 0.1%. And even that could well be too optimistic given the official Chinese statements that the extra imports depend on the development of Chinese demand. 

On the other hand, aren’t we missing a big confidence boost from the deal since the truce reduces the chance of new tariff hikes by the US? Well, the ink on the deal was barely dry before President Trump had returned to making trade threats, this time in an attempt to strongarm the European Union into opening its agricultural markets to the US and to encourage Europe to co-operate with American policy on Iran. No surprise there, as tariff threats have become a favourite tactic of the president to help create leverage in foreign policy. The prospect of further trade conflicts is never far away while he is in the White House.

So there is little reduction in uncertainty for markets to enjoy. In line with this, I expect business to continue their ‘wait and see’ approach with regards to investments, which implies only modest growth of industrial production. Therefore growth in world trade will be limited to around half of one per cent. That is pretty dismal compared to the 1.8% growth seen on average during the 2010s.

Trade Tensions With Europe Flare as Trump Flexes Economic Muscle U.S. threats to place tariffs on some of its closest allies show that economic pressure is still President Trump’s preferred weapon in international disputes.

(…) Mr. Trump, in an interview on the sidelines of the World Economic Forum, said he would impose new tariffs on European car imports if the European Union didn’t agree to a new trade agreement. (…)

The double salvo shows Washington will continue efforts to bend other nations to its will by applying economic pressure on allies and adversaries alike—everything from sanctions on longtime adversary Iran to possible tariffs for longtime partners in Europe.

(…) the U.K. said it would go ahead with its digital-services tax in April if no comprehensive, multilateral deal on how tech companies should be taxed was found. (…)

The EU has promised to respond to U.S. tariffs with levies on about $100 billion of trans-Atlantic trade. Talks on removing barriers to U.S.-EU trade have stumbled on several issues, notably pressure by the U.S. on Europeans to open their agricultural markets to U.S. companies. (…)

In Trade With China, the U.S. Is Missing the Point What matters isn’t plugging the trade deficit but making sure the U.S. keeps exporting complex products

Thirty years ago, China’s exports to the U.S. were dominated by clothing and footwear. U.S. exports to China were more mixed, containing both commodities and products requiring a lot of know-how, such as aircraft. Now, the U.S. is even more focused on commodities, whereas China’s top exports are complex goods like computers. (…)

The most successful measure of export complexity—as compiled by the Observatory of Economic Complexity—is how hard it is for products to be sold abroad given competition from other nations. Entering the market for electric cars is harder than for corn.

This points to the key problem for developed economies in China’s rise. Whereas in mainstream theories everybody can grow without impairing others, in a battle for economic complexity there are losers—those that get stuck making the low value-added stuff.

The U.S. is far from just a lowly commodity exporter. It leads the world, among other things, in high value-added services exports, thanks to the dominance of technology giants like Google and Apple. However, an excessive focus on trade deficits seems to be pushing it in precisely the wrong direction. What matters is preserving markets for America’s most complex products and services. (…)

• The Great U.S.-China Tech Divide The two countries are headed toward a world where they will have mutually exclusive systems for all important forms of technology.

(…) A battle that had centered on the telecom industry, with the U.S. effort to globally blacklist Chinese giant Huawei Technologies Co. over fears of potential spying and cyberattacks, has burst into a much wider conflict that has altered virtually every part of the technology sector on both sides of the Pacific. Huawei has responded by taking steps to divorce its entire supply chain from the U.S. (…)

Driving the American side of this conflict are not only worries about spying, cybersecurity and blackmail, but also concerns that the U.S. is losing ground to Beijing in the race to develop and implement the latest technology, including artificial intelligence. (…)

The U.S. exported about $7 billion of chips to China in 2018, substantially more than it imported from China. (…) Putting the screws to trade is forcing China to develop its own industry and seek new, non-U.S. suppliers—things the country has already started to do, hurting American chip makers’ revenues. (…) “As the Chinese companies strengthen, the pie available for U.S. companies gets smaller.” (…)

In that [social media] arena, the Trump administration has ratcheted up pressure by threatening to undermine Chinese companies’ bids to build user bases in the U.S. (…)

In such a world, the race for technological dominance could come with high stakes, handing the winner a stronger economy and greater global influence than it could gain in a more integrated market. (…)

Mr. Spalding, the former National Security Council member, says one American concern about Chinese ownership of popular apps is that it gives Chinese companies more data that they can use to improve their artificial intelligence.

Mr. Jones of International Business Strategies emphasizes the importance of AI to both countries. “AI is high on the priority list, and we think AI is a major differentiator in areas like autonomous driving, virtual reality, augmented reality and even medicine,” he says. “We think AI is going to be a key factor in terms of who’s going to win and lose in the next five to 10 years.”

Trump’s Pyrrhic Trade Victories In search of easy wins, the U.S. is throwing away its best cards: fairness and the rule of law.

Historians will puzzle over this turn of events: A Republican U.S. president endorses central planning for trade, while a communist government in China cautions, in its trade deal with the U.S., that international commerce must reflect “market conditions.” The American president boasts about raising import taxes on Americans and restricting immigration, while the Chinese lower trade barriers, encourage foreign investment and rely more on open-source software.

The administration’s “phase one” deal with China commits the government in Beijing to prescribe amounts of purchases of U.S. agricultural and manufacturing goods, which only magnifies the Communist Party’s role in the economy. The deal permits each side to use its own statistics, so China will likely “meet” some quotas by reclassifying U.S. exports to Hong Kong that middlemen sell to the mainland. Beijing will redirect commodity purchases—fuels, food, chemicals—but other importers will shift from U.S. producers to third countries. Mr. Trump is paying a price to manipulate the bilateral trade balance, and it won’t affect America’s overall trade deficit. The numbers will likely conflict, leading to more fights—after the election. (…)

How Many Tariff Studies Are Enough? The trade war hits consumers and exports, two more papers say.

The evidence of economic harm from tariffs keeps piling up. Two studies out this month from the National Bureau of Economic Research (NBER) indicate—again—that U.S. tariffs are paid almost entirely by American consumers, while illustrating how they also act as a drag on U.S. exports.

The first paper is by economists at the Federal Reserve Bank of New York, Princeton and Columbia. They examined data on U.S. customs through October 2019. By then, as they calculate, the average U.S. duty had more than tripled, from 1.6% to 5.4%. But foreign firms generally did not cut prices to compensate. Instead, “approximately 100 percent of these import taxes have been passed on to U.S. importers and consumers.” (…)

The second paper is by economists at the Federal Reserve, the University of Michigan and the Census Bureau. Their focus is the weakness in U.S. exports, where growth has been flat or negative, even when excluding “exports to China or products facing retaliation.” What gives? One factor, as they wryly explain: “Firms’ reliance on global supply chains can complicate the application of traditional mercantilism.”

By value, the items on Mr. Trump’s many tariff lists are mostly—57%, the study says—intermediate goods. Hence the boomerang effect, since American companies use these inputs to make their own products. The authors add that “84% of total U.S. exports were by firms facing at least one import tariff increase.”

Those companies represent 65% of manufacturing employment, another big concern for Mr. Trump. “For all affected firms,” the economists estimate, “the implied cost is $900 per worker in new duties.” For manufacturers, it’s even higher: $1,600 per worker.

This fits with the rest of the evidence. A study from the Federal Reserve, which we recently wrote about, said: “A small boost from the import protection effect of tariffs is more than offset by larger drags from the effects of rising input costs and retaliatory tariffs.” An NBER paper in March said that “the full incidence of the tariff falls on domestic consumers, with a reduction in U.S. real income of $1.4 billion per month.” Don’t forget the duties on washing machines, which researchers say raised prices on washers—and also on dryers—by about 12%.

Protectionists may defend their policies on political grounds, but that means ignoring the mounting evidence of economic harm.

Robert Zoelick, the former World Bank president, U.S. trade representative and deputy secretary of state, added in the opinion cited above this one:

His new tariffs will cover almost two-thirds of U.S. imports from China, with an average tax of almost 20%, compared with 3% before. China’s retaliatory tariffs hit almost 60% of U.S. exports, with an average rate of 20.5%, up from 8% before the current administration. And remember Mr. Trump has had to pay about $25 billion to compensate farmers hurt by his trade war. Farmers suffered a 24% surge in bankruptcies in 2019, and the U.S. lost about a percentage point of growth (another $200 billion), according to a Federal Reserve study.

SENTIMENT WATCH

SentimenTrader keeps track of myriads of indicators but, focusing on the options market, it says “It just keeps getting crazier.”

Perhaps the most telling measure of speculative excess is when options traders buy an extreme number of speculative call options. (…) And it just hit a record high for the 2nd week in a row. (…)
The only other week in the past 20 years that neared 20 million contracts was 19.8 million during the week of January 26, 2018.

As a percentage of total NYSE volume, (…) at this point, it’s going parabolic. (…)

The number of call option contracts bought to open minus sold to open has skyrocketed over the past two weeks. We’ve never seen anything like this before. (…) The Options Speculation Index continues to climb to thresholds not seen since the peak of the 2000 bubble.

Among everything we follow, this kind of behavior is by far the most troublesome and should be a major worry for anyone buying with a medium-term time frame.