Market analysis: Conciliatory Trump will lift sentiment

If this is indeed a new start in the approach by Donald Trump to international relations, it is likely to be welcomed by the markets.

The US president’s cordial meeting with Japanese prime minister Shinzo Abe, left, allayed fears of a global trade war. Carolyn Kaster / AP Photo

Currencies and trade have been at the forefront of the Trump White House in the weeks since the inauguration in late January. However, with the visit of Japan’s prime minister Shinzo Abe to Washington over the weekend, it appears as if some of the aggressive tone has begun to soften, which will be a welcome development for financial markets if it is maintained.

Having withdrawn from the Trans Pacific Partnership, promised to renegotiate Nafta and threatened Mexico and China with tariffs, as well as the criticism of global trade deals and of the financial practices of America’s global trading partners, have been some of the hallmarks so far of the Trump presidency. Early in his administration, Donald Trump said “you look at what China is doing, you look at what Japan has done over the years. They play the money market, they play the devaluation market and we sit there like a bunch of dummies”.

In the past, Mr Trump has frequently threatened to name China as a currency manipulator, even though its current account surplus is less than 3 per cent of GDP and its forex reserves are falling rather than going up, factors that put it outside of the US treasury’s formal definition of “currency manipulation”.

Mr Trump’s advisers then went on to criticise one of the US’s oldest allies, Germany, pointing to an undervaluation of the euro and the surge in Germany’s current account surplus to about 8 per cent of GDP, which is regarded by the IMF as a significant contributor to global imbalances. Last week Germany posted a record trade surplus, something that will not have gone unnoticed in Washington.

Considering that Japan has the second-largest trade surplus with the US after China, and that its current account surplus hit a nine-year high of US$183.7 billion last year, up 25 per cent on 2015, and the second highest on record, it might have been thought that Japan would be next on the list of offenders approaching Mr Abe’s trip to the US this weekend.

Hence the markets were looking at the meeting with a degree of trepidation. However, the tone of the discussions was surprisingly cordial, with the two leaders pledging to begin new talks on bilateral trade and investment, and with Mr Trump calling Japan a “steadfast ally” after their talks.

On Thursday, Mr Trump also sought to defuse tensions with China, by pledging to honour the “One China” policy, acknowledging Beijing’s position that there is only one Chinese government, a message that went down well with president Xi Jinping.

If this is indeed a new start in the approach by Mr Trump to international relations, it is likely to be welcomed by the markets. For one thing the risk of a global trade war and accompanying financial market stress and volatility was becoming a significant one, with Mr Abe having already warned in a speech to the US chamber of commerce of the threat to the world economy from mistrust between the world’s largest nations, leading to a global trade war.

The financial market consequences could also be considerable. Japan has also recently overtaken China as the biggest official foreign holder of US treasuries, with Japan and China having the option of dumping US debt holdings in the event that relations descend into an all-out trade war. A black hole could then appear in America’s external funding, in all likelihood causing US borrowing costs to go up, and requiring domestic savings to fill the gap.

A new start would also be welcomed if it means that the White House gets back to its other major economic policy priorities set before the election, namely the provision of a significant fiscal stimulus and widespread deregulation to drive up economic growth.

This also appears to be finally on its way. US equity markets touched new highs last week as Mr Trump said he would be doing “something phenomenal in terms of tax” in the next two to three weeks. The president also reiterated that he would look to roll back regulation. So far, the Trump White House’s pro-growth economic agenda has been overshadowed by trade and currency concerns that could end up being negative for growth.

The markets are finally beginning to hope that this is about to change.

Tim Fox is the chief economist and head of research at Emirates NBD.

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