Impact of US tariffs to stay Fed's hand in Q4, UBS predicts
Economists at UBS no longer see the US central bank hiking interest rates in the fourth quarter 2018, anticipating instead that the drag on growth from tariffs will stay the Federal Reserves hand.
In a research report sent to clients on 23 July, economists at the Swiss broker led by Seth Carpenter noted the US administration's decision, during the previous week, to start an investigation into Chinese trade practices.
That led them to the conclude that trade tensions were set to escalate, with taxes on another $200bn-worth of Chinese goods likely by September, they said, which would see GDP growth slow to a pace of 1.7% over the final three months of 2018.
"A risk-management approach by the Fed causes them to defer hiking. [...] Moreover, the longer list of imports will include categories without ready alternative sources. Newly established firms will struggle to find replacements and absorb the cost shock; some will fail," they wrote.
On the other hand, their forecast for year-end 2019 inflation, as measured by the price deflator for US personal consumption expenditures, the Fed's preferred inflation gauge, was unchanged at 2.1%.
The roughly 6.5% appreciation in the US dollar versus China's currency, the yuan, and the impact on prices from tariffs would largely offset each other, UBS added.
Nevertheless, officials at the US central bank would afterwards resume with their gradual pace of policy tightening, the investment bank predicted.
"The Fed will focus on the real-side effects, not inflationary effects. The Sharp deceleration in Q4 makes the Fed skip a hike in our forecast. Supply shocks push up inflation and push down growth, but the Fed will be convinced that any inflationary boost will be temporary. The downside risk to growth will stay their hand.
"In our forecast, the economy recovers quickly, so the gradual hiking strategy continues," the economists said.
And what about the most likely response from Beijing?
UBS believed a proportional reaction from China was unlikely, as it would mean levying taxes on all imports from the US, because of the simple fact that the Asian giant bought fewer goods from the other side of the Pacific than America did.
It would also carry with it the risk of further escalation from Washington.
"Instead, our colleagues believe a strong protest and minor retaliation will be paired with macroeconomic policy to cushion the blow to the Chinese economy."