Trade War Takes Center Stage at G7

Nathan is chief Economists and head of macro economic Research for p g i M Fixed Income based in Newark, New Jersey, but joining us live here in our Bloomberg and or Active Brooker studio. So, Nathan, I mean, there's so many topics to talk about here. Um, just last week, you know, we had the Fed, we had trade, we had tariffs and so on and so forth. Let's start with trade because that seems to be, uh, the number one issue driving financial markets here just given what we've

seen over the last several days, several weeks. How do you think this could play out? And what how are you kind of you know, thinking about your portfolio and global trade uncertainty. So it's a pleasure to be here, and as you say, uncertainty is certainly the word of the day and probably the word of the week. I would uh say that the president's remarks this morning that he's received a call from the Chinese and they want to negotiate, actually it should be interpreted as saying President

Trump wants to negotiate. Um. My feeling has long been that he's not inclined to want to push the markets or the economy uh to to the precipice or to the breaking point. And so I would expect that the administration will be uh finding ways to come to the table. And then the key question is how did the Chinese respond to that? All right, So we could get out a book to analyze both characters and what's going on

in their mind space, but that might prove fruitless. I think one of the key questions here is moving forward, how much damage is already happening with respect to businesses and their plans. Do you have a sense of that? Well, right now we have a two speed to tier US economy. The consumer sector in the labor market are quite solid, but the business sector is is really feeling a meaningful imprint of the uncertainty that you described. Which I think

is largely about this trade wall. I guess that there's a question, there's sort of an understanding or a feeling that Trump President Trump will back down or come to some kind of deal in order to save the markets and save the economics. It doesn't want to go into with a stock market that's crashing. At the same time, it's hard to know how much can be rolled back.

At what point do we hit the point of no return and businesses have already changed their plans so much that even some sort of trade truce could not bring necessarily markets back. And uh, I think that Uh, I think that's an open question. My feeling is that we're

not there yet. But if we get to a point where we have say, thirty percent tariffs on everything that the United States is importing uh from China, and sanctions on whalwei, and the list goes on, we may very quickly get to that point where the impact on US business on investment and investment plans is essentially irreversible, which means that recessionary forces at that point will be will be quite powerful. I don't think we're there yet, but

it's it's a possibility. So on the flip side. To what extent are the tariffs impacting the Chinese economy do you think? I think the uh, the impact on the Chinese economy is quite substantial. My rule of thumb is that if if the tariffs are taking say three or four tenths of a percent off the level of US GDP, that it's at least twice that much for the Chinese economy. So the Chinese are certainly absorbing a meaningful economic shock,

and I think you're seeing that in their numbers. But the key here is that China also has a higher pain threshold. So that's kind of the challenge the US. We're feeling less pain, but we have a lower pain threshold. China more pain and a higher pain threshold. How how do these incentives that result from that? How do they play through well? And I guess that that's the question. You know, China seems to be playing a more hardball this morning than President Trump, indicating that there have not

been material talk. So at what point will they be forced to the table, regardless of the fact that they've got a higher pain threshold. So I think that China, I don't know the mechanism to force them to the table. I do think that as they feel economic effects and as the Trump administration UH puts gifts in the negotiation on the table. I mean one of the challenges before I was at the U S Treasury and I would negotiate with the Chinese, one of the challenges was the

U S didn't have gifts for the Chinese. We were asking them to do things, but we didn't have a lot to give back. Now the US has has Wahwei, we have currency manipulation, and we have tariffs, and so I think it does open up a negotiation. We're both claimed. Both sides could claim a UH a scope for victory or that they got something from it. So you mentioned Hahwei. That is a part of the negotiations that sometimes gets forgotten, but that could in fact be a material stumbling block.

How how did does that play into it? So I think Hahwei is critical. I think that if the Chinese leaders were, you know, to disclose what they feel are the key issues, Whahwei would be at the very top of the list. So I think that progress from the Chinese standpoint, progress on hahweis is central. Then the question is, UH, to what extent does the US actually see wahway as a national security concern. And even if the administration is inclined to want to be software a wahaway, will Capitol

Hill allow it? So I think always somehow has to be included, but there are lots of question marks there. We're speaking with Nathan Sheets. He's chief economist and head of macroeconomic research at PGM Fixed Income. Just by way of background, you also were under the Secretary of the US for the U. S. Treasury focusing on international affairs. You're representing the U S. Governments. You come with with

quite a bit of authority on these issues. From an investment side, How would you advise or how are you advising? UH had a position around this uncertainty at a time when growth is still okay. Yeah, so we are. We are at a in a place where there is enormous demand for safe assets, and I think con significant that in that world we see the end appreciate, we see

the tenure treasury yield UH decline. UH investors are are are seeking those places where they can have some confidence that they'll actually they'll actually be repaid and we'll be able to weather a storm. And frankly, that's my feeling. This is uh, this is a challenging environment for risk on kinds of assets. We are awaiting the press conference with President Macron of France and President Trump of the United States that is coming up in moments. We will

carry that live. Uh, Nathan, was there anything that came out of Jackson Hole last week that surprised you or kind of made you rethink maybe a little bit of your outlook? So H J. Powell's remarks were I thought, just a restatement with emphasis of what he had said at the July press conference. The Feds in the midst of a mid cycle adjustment, which likely means one or

two more rate cuts, but they're watching closely. Uh. The The additional thought that emerged from what Powell implied and then what some of the other speakers that Jackson Hole uh spoke about is there was a symphasis that central banks can't entirely fix the trade war. And I think that's a recognition that there's the risk of a vicious moral hazard feedback loop where central bank see a week economy cut rates and that gives the president more scope

to pursue the trade war. And I think that that was more in the background of Jackson Hole than it had been in previous FED communications. You were saying earlier that you do think that haven plays are a good place to go right now or people are going to get their money back and they have that confidence. I guess there's a hup side to that. Those are getting very crowded, and there is a potential that if there is some sort of trade truce that could completely upend

the way that people are positioned. What sort of the chance of that near opinion? So, I would say, over over say a six month horizon, I think that both sides, both as I've described, both the US and Chinese have incentives to find something that they can call on agreement and de escalate where things are in the nearer term, I don't see how we get to a d D escalation. It's gonna be, It's gonna be a ways and uh,

you know, hopefully over time we'll see it. But I wouldn't put a high probability that over the next few weeks somehow this all magically goes away. I wish I could be more optimistic. And to what extent do you think that? I mean, well, that way on corporate America, you know what we're gonna see see it in the

earnings coming up. And we we've seen, we've we've heard certainly in the past couple of quarters of earnings that you know, CEOs across a variety of industries have highlighted the uncertainty of the trade negotiations kind of either weighing on their business, weighing on their customers businesses, affecting maybe capital spending in R and D. When do you expect to see, you know, a big impact on corporate America.

So we are seeing a a lackluster global economy, and I think that these even as the US economy is doing all right, the rest of the world is feeling adverse effects. As we describe the Chinese economy has slowed. I think they're stimulating, but UH, the underlying economy there is soft. The European economy is slaw, particularly in the manufacturing sector, and UH and global growth is meaningfully below trend.

And I think given all of that, that's going to leave a signature in UH, the earning of Corporate American. A large share of those earnings do come from their their their operations abroad. Just lastly, here to wrap things up, you talk about haven bets, you talk about how it wouldn't be a really prudent thing to go into risk assets, and yet we do have a tepid rally underway today on some of these tweets. How long can markets continue

to melt up? Good question? Good question. Uh, you know, I think what's supporting the equities is the fact that corporate earnings so far been okay, coupled with lower long term interest rates, and so discount factors are are are are affected accordingly. And you put that together, I mean, where else are you going to go other than the US equities? So there is a narrative that things are

hanging in there. Okay. In the US bonds look maybe a little less attractive for the reasons we've described, and uh, you know, equities are done well, and maybe things maybe we're all too pessimistic. Nathan needs thank you so much for being with. Nathan Sheets is chief economist and head of macroeconomic research at p JIM Fixed Income, which overseas more than eight hundred billion dollars here so, uh, formerly worked on international trade negotiations for the US Treasure Department.

So he comes to this with a good deal of experience and insight. Thank you. What is an investor to do as we get a deepening uncertainty around trade negotiations, around global growth, around a lot of things, leaving a lot of investors sitting on their hands and wondering what direction to take next. Not sitting on his hands, Phil Orlando joining us here at our blueborgod Active broker Studios.

Phil is chief equity and market strategist and head of client protfolio management and Federated Investors, which overseas more than a four hundred and eighty billion dollars. Fill. Let's just start with what we just heard from President Trump, because that has been sort of the prevailing force in dictating some of the volatility right now. How much would you be trading off of any kind of development on trade on any given day? Uh, The answer is not much.

UM that that clearly the market is under some pressure given the escalation of trade and tariff war between the U S and China. UH. If you listen to this press conference, there's a lot of pushback from the reporters who were there, questioning the veracity as to whether or not the Chinese had actually reached out to the US over the last twenty four hours to restart UH talks

ET cetera. And um, I'm not sure if the president was able to say any of their desire for some corroborative information and to suggest that the talks are back on track. I happen to think that the China issue UH is probably one of the three most important issues that investors are focused on right now. And I think all three of these issues are probably interrelated, UH, the China trade war, what's the Federal Reserve doing in terms of monetary policy, and the inversion of the yield curve.

And I think that, you know, depending upon what you want to talk about today, all of those issues UH are significantly inter related in my mind. So it's interesting. I think we used to see the least as we sit here and look at our screens every day and we say and we and we see the markets reacting to the tweets as it relates to trade. So clearly

trade is a big, big issue for investors. To what extent would this be, you know, a a real drag on the market in general, If in fact these negotiations drag on too maybe pass the election, for example, well it would be a significant drag. And and our Bay case has been that there were significant fiscal policy reasons for why Trump had initiated this trade war, if you will. We've talked about this before, but you look at the math, uh.

We the United States running roughly a six hundred billion dollar balance of trade deficit in a twenty one trillion dollar economy. That that's costing US about three percentage points of GDP growth. When you look at the composition of that deficit, roughly two thirds of it, let's call it four billion dollars is related to China. China's running a four billion dollar surplus against the United States. The United States, Trump,

I think was trying to achieve two things here. Try to balance out narrow, have the size of that deficit, cut it from four to two billion, and in the process boost GDP growth by one percentage point potentially. The other thing is the structural issues that have been ongoing now for the better of twenty five years, and by that I mean the theft of intellectual property, the currency manipulation. Uh. These are ongoing developments that that that President Clinton didn't address,

President Bush didn't address, President Obama didn't address. Yet US companies have been sort of pounding on the White House's door for a long time suggesting that that we our administration should attempt to do something about it. So so I think you've got sort of a two front war, the structural issues and and an effort to try to narrow the deficit and and potentially boost GDP growth in the process. Phil was the last time it materally changed

your recommendation for allocation? Uh we UH started the year, remember the declining stocks in the fourth quarter uh SMP was down about the level. In our view that that that was a complete head fake, that there was nothing structurally wrong with the economy. We thought that toxic sentiment was what had driven the market down. So we actually took our allocation up to an eight percent equity overweight.

We felt that stocks from that Christmas Eve bottom, we're gonna rebound about thirty two percent over the course of this year. Our target was thirty Where we stand now at the end of July, we we took our allocation down from an eight percent overweight to about a three percent overweight in terms of our model and in July and in our global allocation fund we're actually managing money. We took that allocation down a neutral. Our view was

that at the end of July. Looking out over the August, September and October timeframe, there were a number of things that concerned us on the immediate horizon, central bank policy, UH and and China. We're we're first and foremost on that list. But as we look out further into that period Halloween, there there are three global developments that are coming together on Halloween that a lot of people aren't really focused upon. We've moved the bregsit deadline. Remember from

March thirty one to Halloween. UM Draggy is going to transition his role as the head of the e c B to leguard on Halloween. UH. And then the Chinese of the Chinese, the Japanese are going to have to make a decision on whether or not to increase their value added tacks from eight percent to ten percent on Halloween.

Why is that important Because the last two times the Japanese increased their value added attacks UH, that decision, that fiscal policy decision, pushed the Japanese economy in a recession. So you've got these three issues at the back end of October. You've got these other issues central bank policy and China trade at the front part of this period. So given the fact that stocks had rallied, we felt that it was prudent to take some chips off the table.

Are there sectors here, given where, given your neutral position, given where we are in the cycle, that still look attractive to you? On the margin, some people have talked about defensive style, but they're not cheap by any stretch. So is there any place for people to look so so, yes, they're not cheap, but but being defensive is exactly where you want to be um having constable demand kind of

companies with with the the outsize dividend payments. Remember the the SNP dividend yield right now is around two percent. Treasury yields are you know, one and a half percent, and and the yields that we can get in in these defensive kind of companies are are north of four percent. For for example, I'll just give a plug for a strategic value fund. That's exactly the sort of things that they do. Uh separate and apart from defense, I think that that small cap still makes a lot of sense here.

For a number of reasons, small caps underperformed large cap by more than a thousand basis points over to last year. Yet most of the concerns that we're seeing are overseas economic concerns. A small cap company is going to do eight percent of their business here. The U S economy is fill in pretty good shape. You've got the dollars pretty strong right now. A strong dollar tends to be very supportive of small cap companies. So for a lot of reasons. Oh and then you know M and A activity.

Companies are are out there actively looking for companies. Greater merger and acquisition activity tends to benefit small cap company. So we still like small cap here as well, domestic small cap. Just real quick, since you didn't mention the yield curve, I'm looking right now at a two tents spread of negative zero point six percent UH, inverting the most since two thousand seven. Do you think that this

indicates recession in the near term? So I would prefer to look at the spread between the funds rate and the benchmark tenure treasury yield. We think that's a better predictor, a more accurate predictor of recession. So you're looking at a tune a quarter up a band of the funds rate with let's call it one and a half percent in the tents. So you've got a seventy five bases point in version there that that's absolutely a signal that

we're respecting. But based upon our analysis of that cycle, we do not see an increased risk of recession before we get into the early part of no recession in eighteen nineteen or twenty. We are concerned about the first half of twenty one. Phil Orlando, thank you so much for joining us. Phil Nando, chief equity market strategist and have of client portfolio management at Federated Investors Investors joinings here on our Bloomberg Interactive Broker Studio. Thanks for listening

to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts or whatever podcast platform you prefer. Paul Sweeney, I'm on Twitter at pt Sweeney. I'm Lisa Abram Woyd's I'm on Twitter at Lisa Abram woits one. Before the podcast, you can always catch us worldwide on Bloomberg Radio.