Stock markets have been in retreat for several months now, despite overall positive global economic indicators. Meanwhile, a number of economists and commentators are forecasting a bear market in the making. Many blame this situation on the prospect of a trade war between the US and China.

Concerns over an upcoming all-out trade war between the United States and China appeared to intensify last week, after President Trump slapped some US$ 50 billion of tariffs on the Chinese. Retaliation was quick to follow, as China countered with roughly the same kind of tariff. President Trump then decided to up the ante with the idea of a new US$ 100 billion tariff plan.

This type of escalation is exactly what many have feared. In fact, in the age of diplomacy by Twitter, it appears to be happening even faster than most had ever expected. Of course, blaming the sluggishness of stock markets entirely on the prospect of a trade war is rather superficial and much too narrow-sighted.

Nevertheless, an ensuing trade war has added uncertainties to the global economic outlook. The economic impact of tariffs is amplified by the collateral damage of increasing protectionism. Trade wars by nature tend to get worse over time. The damage is felt by financial markets. And it will certainly be felt much more intensely in the current context, where inflationary expectations are on the rise and protectionism will tend to drive up prices for consumers.

Stock Market indices in Major Advanced Economies

Source: Federal Reserve Bank of Dallas; Database of Global Economic Indicators; Haver Analytics​

The Global Economy is Looking Relatively Good

Stock markets have been largely in retreat in 2018. However, a good number of global economic indicators still look relatively positive. GDP growth has been improving bit by bit in the U.S. as well as in other advanced economies. OECD Industrial production and World Merchandise Trade are rising and are higher than they were before the 2008 crisis.

Meanwhile, unemployment rates have been falling in all major advanced economies and the OECD in general.

Real Gross Domestic Product

Source: Federal Reserve Bank of Dallas; Database of Global Economic Indicators; Haver Analytics

Unemployment in OECD Economies

Source: Federal Reserve Bank of Dallas; Database of Global Economic Indicators; Haver Analytics

Volume of World Merchandise Trade

Source: Federal Reserve Bank of Dallas; Database of Global Economic Indicators; Haver Analytics

The data series depicted in the chart above, on global merchandise trade, includes data from 23 industrialized and 60 emerging market economies. It covers approximately 97 percent of total world trade.

So why worry?...

If the global economy is on a growth trajectory, why are some economists concerned about financial markets and the prospect of a trade war? Well, first of all, not all indicators are looking up. Some do raise concern.

Global Purchasing Managers Index

Source: Federal Reserve Bank of Dallas; Database of Global Economic Indicators; Haver Analytics

One early indicator watched closely by investment advisors and economists is the PMI, the Purchasing Managers Index. Although the PMI is still well above 50 and therefore still relatively positive, its recent dip has given cause for alarm.

The other indicator that has recently been in focus is yield. Government bond yields have been rising since 2017. And money market spreads, particularly in the US, have displayed a rapid upward tick in 2018. Meanwhile, the U.S. Federal Reserve has started raising the federal funds rate. Other central banks, after decades of increasingly expansive monetary policies, are starting to enter into a tightening phase as well.

Money Market Spreads

Source: Federal Reserve Bank of Dallas; Database of Global Economic Indicators; Haver Analytics

Finally, while inflation is still very low globally, signs of a rise on the OECD horizon have justifiably given rise to serious concerns, particularly in the wake of higher interest rates and at a time when public and private debt is higher than ever before.

Inflation in OECD Economies (CPI)

Source: Federal Reserve Bank of Dallas; Database of Global Economic Indicators; Haver Analytics

Trade wars pile on uncertainty and unwelcome concerns

So, as is often the case, there is no clear outlook for the global economy. The signs are murky and multiple uncertainties exist. The reason why trade wars are often cited as such a “huge” problem today, has partially to do with the fact that “Trump-bashing” is “en vogue” and blaming a potential recession on President Trump appears opportune.

More importantly, however, it has to do with the overall state of the global economy and global financial system. It is loaded with debt, derivatives and bond-heavy balance sheets. An era of protectionism and trade wars would certainly increase the probability of a more rapid increase of inflation and yields.

President Trump’s criticism of Amazon has also added to the worries over a trade war. If new policies taking aim at Amazon are enacted, that could rapidly lead to higher prices for tens of millions of consumers who shop on Amazon. In addition, there are rumors of a possible Internet Sales Tax, another boost to consumer prices and a damper on spending.

Commodity Prices

Source: Federal Reserve Bank of Dallas; Database of Global Economic Indicators; Haver Analytics

All this, of course, will have negative effects on bond and stock markets, while it should be good news for commodities and gold in particular. Whenever financial markets enter a correction phase, particularly in combination with inflation, gold tends to shine. After double-digit gains last year, this year looks even more promising for gold investors.

Economic facts for all to see: Regularly, the Federal Reserve Bank of Dallas publishes numbers regarding the global economic conditions. They just published the latest collection of economic indicators for April 2018, some of which we have shared here. If you’d like to review the data in more detail, go to the following link:

,,https://www.dallasfed.org/-/media/Documents/institute/global.pdf