Because of the interconnected global supply chain, uncertainty spread from businesses in the U.S. and China to those elsewhere in Asia, Europe and the Americas.
“The globe is connected through supply chains,” said Rajan. “If you start boosting tariffs on goods from China, it disrupts the supply chain. That means your exports are also to some extent affected. Even as China’s exports plummeted, the U.S.’s exports also fell, as did Europe’s exports.”
In response, a new wave of volatility has impacted global financial markets, only punctuated by moments where market participants feel confident that some sort of trade agreement is in the works.
The Federal Reserve, once eager to proceed down a path of steady interest rate increases to get ahead of inflation and the next recession, has also changed course.
“As a result, we have had policy reversals: The Fed went 180 degrees from saying it was going to raise rates and that it was not concerned about volatility, from taking away the Fed put, this idea that the Fed would always intervene when the market falls,” said Rajan. “Everything came back on the table. They said ‘we’re not going to raise rates, we’re going to be careful about the state of the economy, maybe it’s not as robust as we thought.’”
The Fed also signaled that it will slow or pause the shrinking of its balance sheet, said Rajan, easing down quantitative tightening and the sale of bonds, essentially signaling monetary support for asset prices.
Overseas, the Chinese were also providing some fiscal and monetary stimulus for their economy, said Rajan.
While financial markets responded positively to the stimulus, trade questions remained. Market participants were operating under the assumption that a deal was forthcoming until the first week in May, when a series of social media posts from U.S. President Donald Trump put the negotiations in doubt. Rajan said that the tweets were probably an attempt to force China’s hand in the trade negotiations.
“The Chinese have backed off in recent weeks,” said Rajan. “The U.S. said ‘if you’re going to back off, we’re going to apply the tariffs we have not yet applied.’ There is some language back and forth – and at least now the Chinese delegation seems to be coming to Washijngton D.C. to deal. It seems like some deal will in fact be done – whether that deal satisfies, whether it’s stable or long-term, and whether it happens soon – all of these are questions that remain to be answered. What we need is a stable, long-term deal to quiet markets and to give them confidence.”
While the uncertainty on trade vexes the market, otherwise the global economy looks healthy in the near term, said Rajan. The U.S. is likely to be the world’s fastest growing industrial economy, and with a more dovish monetary policy, international and emerging market assets are likely to perform well.