Hamish McRae

With hindsight, Rachel Reeves’s first Budget in October last year looks even worse than it did at the time. It wasn’t exactly cheered to the rafters then, even by Labour’s own mass of backbenchers, but a year on it has become clear that those early decisions have damaged the country’s economic performance and blighted Reeves’s time in the Treasury. The Chancellor has been somewhat unlucky, to be fair, but she made three crucial errors in the October Budget. First, she did not give herself enough slack if the economy took a turn for the worse. Second, she forgot that economics is not only about numbers but also about mood.

We’ve learnt three things about the future of world trade from the temporary reprieve over tariffs that the US has given China – and China’s response to it.  One is the markets are now confident that both countries will be sensible. The massively negative reaction they gave to ‘liberation day’ on 2 April signalled their hatred of uncertainty but also of stupidity. Before Donald Trump’s arbitrary jacking up of tariffs to what were really absurd levels, they had assumed that he would ensure that there would be reasonable continuity of world trade. His plans, and China’s robust reaction, led to nagging doubts that their assumption might be wrong, there really would be a destructive trade war between the world’s two biggest economies. The S&P index duly plunged.

It’s that moment of supreme uncertainty. We do however know the question. Is this a regular sell-off, with the S&P500 nudging into bear market territory, but then steadying in the next few months before a gradual recovery? Or is this a true crash, akin to those of October 1929, October 1987, October 2008, or most recently March 2020, in which case we are less than halfway down the peak? The strategists have of course been crawling over the data of previous crashes, but the analogies never really fit. There has not been a trade war akin to what may be developing now since the 1930s, when the world economy was both less integrated and more fragile. The confident predictions of a couple of weeks ago that US equities would end up this year now look rather silly.

Could it be that Donald Trump actually wants a bear market now? At some point, one was bound to happen on his watch — after all, US equities weren’t going to keep up their stunning gains from the past two years for the rest of his term. A market correction was inevitable, and it seems we’ve already seen that, as the S&P 500 dipped into correction territory this week. And a bear market was almost certainly coming, given that there have been 27 of them in the S&P index since 1928. Hartford Funds provides a good summary here, showing that the average decline in a bear market is 35 percent, and they typically last 9.6 months. By contrast, the average bull market lasts 2.6 years, with prices rising 110 percent. Overall, bear markets occur about every 3.

The plunge continues. It’s always a mug’s game trying to call the top of any market, but the plunge on Wall Street does feel as though it has got legs, so it is quite possible that we have indeed seen the peak for US equities.  Since last week the Nasdaq has moved into correction territory – jargon for a 10 per cent or more fall – and on Monday was off another 3 per cent. I rather like the expression ‘correction’ because it implies that the markets have simply made a bit of an error, a ‘terribly sorry, folks, but we all make mistakes, and give us a few weeks and we’ll correct them’ sort of thing.

China does not like tariffs, but big money in America likes them even less. If one thing has become clear amid the fog of the past week, it is that what will contain Donald Trump are the financial markets. China’s foreign minister, Wang Yi, attacked Trump on Friday for his imposition of tariffs, adding that major powers ‘should not bully the weak’. While people in Taiwan might find that latter comment a bit rich, his line on tariffs squares with the reaction on Wall Street. The markets do not like it. This week has seen the Nasdaq Composite index of high-technology companies move into a ‘correction’ – a 10 per cent fall from its peak.

Do we have to choose between prioritising European or American trade? Let’s hope we don’t, because we need both. But the question has sharpened this week for two reasons. The less important one is that Maros Sefcovic, the EU’s new trade commissioner, has suggested that the UK might join the Pan-Euro-Mediterranean Convention, a group of 23 countries with economic ties to the EU, including Norway and Switzerland, but also Ukraine, Turkey, Israel, Algeria, Morocco, Jordan, Lebanon and so on. It’s not a free trade area or anything like that, merely an agreement to foster trade by streamlining things like rules of origin.

The UK economy may end up growing a bit faster by the end of this decade than the Office for Budget Responsibility expects – but if it does that will be no thanks to Rachel Reeves’s Budget.  The OBR’s projections are unambitious. This is their summary: ‘Having stagnated last year, the economy is expected to grow by just over 1 per cent this year, rising to 2 per cent in 2025, before falling to around 1½ per cent, slightly below its estimated potential growth rate of 1⅔ per cent, over the remainder of the forecast. Budget policies temporarily boost output in the near term, but leave GDP largely unchanged in five years.

Who would pay for Rachel Reeves’s increase in employers’ National Insurance contributions? Well yes, in the first instance it is the companies that would have to hand over the cash, but the real burden would be much more widely shared. To see why, start with the simple question: what does a company do if it finds its labour costs have suddenly gone up? It can do nothing, in which case its profits fall (or even less agreeably, its losses rise) and it pays a bit less in corporation tax. It can trim its workforce to hold costs down, which will cut the government’s take from income tax, and – of course – from National Insurance. It can increase its prices, in which case customers pay. It can cut or postpone investment, accepting some damage to future growth.