Trade conflict fears have disrupted trade chains and put a dent in global economic prospects. In response, central banks have stepped in. The Fed has said that it will “act as appropriate” and the ECB has said that, without improvement, “additional stimulus will be required”.
For the moment, this is just a statement. The global economy has yet to slow further and central banks haven’t yet cut rates. But the central banks’ commitment is an important one. Financial markets believe that policymakers’ promises will be honoured and that monetary policy intervention will blunt the market impact of slower growth.
Such central bank promises create some risks. Even though inflation remains stubbornly low, and below target, most economic data do not yet provide a good reason to cut rates shortly. But if central banks do not cut rates, their authority could start to be undermined because they have raised expectations about lower rates to the point where it would be awkward to backtrack. This may provide an incentive to cut rates more than would normally be the case – good news for markets in the short term, but not necessarily in the long term.
There is also a non-optimal solution in that central bank action is partly being used to counter the effects of an escalation in the trade dispute and the resulting shifted patterns in trade flows – thereby quite possibly prolonging trade friction longer than it might have lasted. Which direction the trade dispute goes and whether there will be new tariffs remains unclear. What we know is that the effects of a trade conflict are long-term and predictably negative; the effects of monetary easing are perhaps short-term and not predictable.
This situation has a direct bearing on our six themes for 2019, which we discuss below.