IFM Investors Economic Update

The volatility that characterised global investment markets in February and March has continued into April. At the time of writing the VIX index is hovering in the low 20s, after averaging, for the last three months of 2017, just below 10. US equities have been swinging between losses and gains on news flow, but remain around 9% off the peaks seen in late January.

Market concerns in the US have been shifting from anxiety induced by the prospect of higher bond yields impacting valuations to fears of an escalating trade war between the US and China. The former was a reflection of improved economic conditions, while the latter came about from speculation around what could be a material negative impact on these two economies and, by implication, the global economy and its financial markets. The headlines suggest the scope for rising tariffs on a broader range of Chinese goods imported to the US will possibly be met with retaliatory action from China’s government. As yet, we do know where this potential escalation will end, given the players involved, nor how greatly markets and investor confidence will be impacted. For now there seems potential for both further escalation and for tensions to dissipate if a bargaining positon could be reached. Economists and investors are clearly contemplating the downside risks to the global economy should the situation deteriorate – whilst hoping a détente is reached.

What is clearer to the vast majority of economists is that protectionists have too readily discounted the benefits of global trade for consumers and businesses alike over an extended period. This policy course is being pursued as they seek the expedient political benefit of protecting domestic labour forces and industry, which have more often than not proven themselves less than competitive in the face of global competition.

In a worst-case scenario of damaging escalation, the fallout for Australia could come via two channels: financial markets and potentially a direct external shock from a weaker Chinese economy. This is despite, at this stage, it being unlikely that direct sanctions on the US by China will have a material impact on Australian industry.

The fallout from global financial markets is likely from volatile and weaker asset markets, prompting economic instability and investor caution. This could impact not only investors, but also households, who may see a reduction in wealth as asset prices decline.

It would also impact the broader economy, companies and governments via weaker commodity prices. Indeed, the opening round of tariffs on steel from the US has seen a pronounced selloff in iron ore prices. Further, the rise in uncertainty both globally and in Australia will do nothing to improve the outlook for much-needed business investment.

Australia: Goods and services exports to China
While goods exports have stabilised, services have exploded


Source: IFM Investors, DFAT

The risk of a direct impact on the Australian economy from an exogenous source will come largely from any material slowdown in the Chinese economy rather than the US (which will clearly have an indirect impact). As is well known, the Australian economy is exposed to China like no other. In 2016-17 China accounted for 23.7% of twoway trade more than the next three countries combined – Japan (9.3%), Korea (5.3%) and the US (9.0%). What is less well known, however, is that it is not just key resources exports but services that define Australia’s exposure. China was Australia’s top goods exports destination by far in 2016-17, accounting for 32.8% of our export trade (or 37.2% if Hong Kong is included). Japan is a distant second, taking 14.5%. Yet China is also our top services export destination by far, accounting for 18.0% of this trade. In this category, the US is second at 10.4%.