Unfortunately, we probably do have a serious Trade War

Most people have been assuming that President Trump’s imposition of tariffs on some Chinese goods that started in March 2018 and has escalated since was largely a negotiating tactic and the prelude to a “fantastic deal” (truce) whereby China made some concessions that would reduce the trade imbalance between the US & China. China’s announcement last week of retaliatory tariffs on some US goods and Trump’s immediate response to further increase US tariffs tells us that we most likely do have a serious trade war and it is not clear that either side is prepared to back down anytime soon. Trump sometimes hints at backing down but subsequently ups the ante again. Trump is using tariffs to try to force China to open its markets to US business, something they are reluctant to agree to.

This trade war between the world’s two biggest economies will harm business confidence globally and has the potential to cause a global recession if it escalates and central banks are unable to reverse the current slowdown in global growth. That would mean lower share prices and lower interest rates; a challenging combination for most investors.

The Washington Post provided a good overview of the extraordinary events of last Friday including the additional U.S tariffs that were announced after the US share market close.


 It’s a crazy world – Government Bonds at negative interest rates

JP Morgan has reported that the proportion of negative-yielding Government bonds has hit a record high of 30%. The chart below gives a breakdown by country. It is hard to comprehend who would pay more for a bond than would be received at maturity but reports suggest the buyers are primarily central banks and pension funds. Hopefully not Australian pension funds! Given the weak global economy, this phenomenon will likely persist. If this seems strange, in Denmark they have introduced negative mortgage rates; yes, the lender will effectively pay the borrower interest.

Increasing signs of a slowing Global Economy

Economic growth has slowed in Europe and much of Asia and as it has been about 10 years since the last U.S. recession, normally we would expect to see another one soon. Since the United States is the world’s leading importer, an American recession always leads to a weakening of the global economy. Massive exporters like Germany and China are particularly vulnerable to such downturns.

Financial markets are concerned and anxiety is deepening by the day. In Germany, interest rates are negative all the way from overnight deposits to 30-year bonds. In Switzerland, negative yields extend right up to 50-year bonds. US interest rates on 10-year bonds are lower than on 3-month bills—often a harbinger of recession. The safe-haven US dollar is up against many other currencies and gold is at a six-year high. Copper prices, a proxy for industrial health, are down sharply. Many fear that these strange signals portend a global recession. Fortunately, a recession is so far a fear, not a reality.

 What are the European Central Bank (ECB) & the US Fed doing about it?

The European Central Bank is leading the charge in the next wave of central bank stimulus measures, but experts and former central bankers argue it will be insufficient to deal with the looming global downturn. ECB governing board member Olli Rehn said the central bank will announce a fresh package of “impactful and significant” stimulus at its September meeting that’s expected to include “substantial” bond purchases as well as cuts to the ECB’s already-negative interest rates.

In addition to negative interest rates, the ECB already has spent trillions buying bonds in an attempt to stimulate the economy. Despite these efforts, major European economies have been unable to generate inflation or growth that’s even close to their targets for years.

The US Fed has signalled a willingness to further reduce interest rates, if necessary, and it looks increasingly likely that this will happen in September.

In Australia, the Reserve Bank has also signalled that it is prepared to further reduce interest rates, if necessary, and it looks very likely that this will happen in September.

Broadly speaking, central banks are gearing up to stave off a recession but some highly respected former central bank leaders now see quantitative easing and negative interest rates — both considered extraordinarily and controversially powerful when they were first discussed — as insufficient to deal with the world’s problems.

Do protests in Hong Kong matter to investors?

While Hong Kong only represents a small part of the global economy, the current unrest has the potential to further exacerbate broader concerns about a weakening global economy and thus have a disproportionate negative impact on investor sentiment.

The uprising started because China has been increasing its control over Hong Kong, including taking much greater control of the criminal justice system. In 1997, when the United Kingdom relinquished control of Hong Kong to China, Beijing was willing to allow Hong Kong to have a high degree of independence because Hong Kong was the financial interface between China and the world. China could not afford to undermine Hong Kong’s dynamism. The growth of the mainland economy means that Hong Kong is much less important to China economically than it was 20 years ago.

The Communist Party of China now derives its legitimacy not from communist ideology but rather from the promise to deliver prosperity to the people, coupled with national pride. Right now, that prosperity is threatened not only by U.S. demands to redefine economic relations between the two countries but also by a global economic slowdown.

China is also no doubt fearful that unrest in Hong Kong could spread to the mainland. People in other Chinese cities might sense Beijing’s weakness and, facing tougher economic conditions, take their concerns and resentments into the streets. This is why Beijing cannot appear to have lost control of Hong Kong. Clearly, China wants the unrest to end but so far it has been unable to achieve this, thus the possibility of a harsh military response remains.

Centrelink Gifting Rules

Changes to the pension assets test introduced effective from 1 January 2017 have created a renewed focus on gifting strategies. Self-funded retirees are not impacted by this. For Age Pension recipients who are asset tested, gifting within the limits can provide an increase in pension entitlements of nearly 8% pa. However, the gifting rules are complex. Centrelink assesses gifting against two limits – $10,000 per financial year and $30,000 over a rolling five financial year period.

The intention of the $30,000 over five financial years rule is to limit the increase in social security entitlements that can be achieved by gifting amounts on an ongoing basis. However, the two gifting rules operate concurrently and contain provisions to avoid excess gifted amounts from being assessable under both rules – which causes confusion.

FirstTech research indicates that the optimal result from gifting by someone subject to the Centrelink assets test is achieved by taking advantage of the $10,000 per financial year limit for the first three years, as well as gifting any amounts that exceed the $10,000 limit as early as possible so that gifting ceases to be assessable by Centrelink at the earliest possible date.

This newsletter contains general advice. It does not take into account your individual objectives, financial situation or needs. You should consider talking to a financial adviser before making a financial decision.

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