President Donald J. Trump listens during a meeting on Fentanyl and the opioid epidemic in the Oval Office at the White House on Tuesday, June 25, 2019 in Washington, DC.
Jabin Botsford | The Washington Post | Getty Images
What will happen next with the global economy and how governments will respond is troubling Wall Street as investors and economists chase a moving target of trade wars and monetary policy shifts.
An index designed to measure policy-related uncertainty around the world is hovering at its highest level ever. The Economic Policy Uncertainty Index hit its second-highest level, 340, in June. It spiked to 341 at the end of last year when the market suffered its worst December since the Great Depression amid the intensified U.S.-China trade war and an ill-advised rate increase from the Federal Reserve, with the major stock averages briefly dipping into bear market territory.
“We found that high levels of policy uncertainty tended to depress investment, depress hiring, in industries that are most exposed to that government behavior,” one of the index’s founders Scott Baker told CNBC.
The EPU Index tracks the amount of times newspaper articles use buzzwords related to economic and political uncertainty. Additionally, it measures the number of tax laws set to expire and the spectrum of disagreement among economists: The more dissent, the higher the index goes.
The accuracy of the index, which tracks data to 1997, speaks for itself. It has spiked during almost every important political and economic moment since its inception, including after the 9/11 terrorist attacks, the 2008 financial meltdown and the 2016 elections in the United Kingdom in which voters approved Britain’s exit from the EU, and in the United States, where Donald Trump pulled off an unexpected victory over Hillary Clinton in the presidential race.
Now, concerns about global economic uncertainty helped spur the Federal Reserve to cut interest rates for the first time since the 2008 financial crisis. After a 25 basis point reduction in the overnight lending rate, Fed Chairman Jerome Powell said “implications of global developments for the economic outlook as well as muted inflation pressures” contributed to the Fed’s decision.
Trump vs. China
President Donald Trump’s “America First” agenda and his accusations of unfair trade practices by China have kept a trade deal between the U.S. and China tied up for more than a year.
Since the Chinese trade officials reneged on a nearly finished trade deal in May, the U.S. and China have engaged in a tit-for-tat tariff war, weighing on business and investor sentiment.
On Thursday, Trump said in a tweet the U.S. is putting an additional 10% tariff on the remaining $300 billion worth of Chinese goods, effective Sept. 1, driving markets, the dollar and oil prices lower.
It is unclear how the trade talks will go if they resume in early September. China may stall a resolution until after the 2020 election, another source of uncertainty overhang, as Democrats juggle 20-plus candidates, some with socialist agendas.
Across the pond
Global central banks have been easing at unprecedented levels, with debt in Europe and Japan at zero or negative interest rates, while still producing weak economic data. Last week, European Central Bank President Mario Draghi signaled that the ECB will likely lower interest rates before the end of the year as “a significant degree of monetary stimulus continues to be necessary to ensure that financial conditions remain very favorable and support the euro area expansion.”
“The risk of a European uncertainty shock remains elevated,” said Societe Generale global head of research Brigitte Richard-Hidden. “The much greater risk is Brexit, or more specifically a no-deal Brexit.”
New Prime Minister Boris Johnson has vowed to get Britain out of the European Union by Oct. 31, with or without a deal with the EU.
‘Uncertainty is the enemy of the business cycle’
Last week, GDP data showed that economic growth is slowing, although not entirely, thanks to strong consumer spending.
A standout number in the GDP report was the 5.5% tumble in gross private domestic investment. Worries over the tariff war with China have been a major driver of business sentiment, with executives expressing concern throughout this quarter’s earnings season.
The decline in capex spending makes sense, given the EPU data.
The creators of the EPU Index, Baker of Northwestern University, Nicholas Bloom of Stanford University and the University of Chicago’s Steven Davis have also found that an economic policy uncertainty shock of 90 points reduces gross fixed investment in the U.S. by 6% within two quarters and lowers GDP by just over 1%.
“Uncertainty is the enemy of the business cycle,” Morgan Stanley’s Chetan Ahya said in a note to clients, and “uncertainty still reigns.”
— With reporting from CNBC’s Michael Bloom