Cautious Sentiment Towards A Trade Deal

Markets continue to focus on the potential for a “Phase 1” trade deal between the US and China.   The stakes are high. President Trump who stated that tariffs on Chinese goods would be “raised very substantially” if no deal was struck between the two sides.  US officials also poured cold water over comments by Chinese officials at the end of last week that there had been an agreement to reduce tariffs in phases.  Markets will take a cautious tone given such comments but it is still likely that a deal of sorts will agreed upon in the next few weeks.

Both sides want a deal and while Trump has said that China wants one more than he does, the US administration may want to avoid fueling market turmoil as attention increasingly turns to next year’s US elections.  This suggests that a Phase 1 deal is more likely than not, but agreement on later Phases will be much harder given that there are various structural issues that remain unresolved such as technology transfers, intellectual property theft and state subsidies.

For now what is important is that markets believe that there is progress towards a deal and an eventual signing probably sometime in December.  Despite the harder rhetoric from the US side this still looks like the most likely outcome which in turn suggests that equities and other risk assets have room to rally.  In the meantime, the situation in Hong Kong where protests have intensified will weigh not just on Hong Kong’s markets but markets across the region adding another reason for market caution in the short term.

On the data and events front attention will be on US October CPI, retail sales and a crop of Fed speakers including Fed Chair Powell who is unlikely to change the view the Fed is on pause for the time being.  Elsewhere Chinese data has been less than impressive this week, with October aggregate financing and new yuan loans both coming in weaker than expected.   This is likely to be echoed by the retail sales and industrial production data this week too.

On the FX front, the US dollar has made up around of its October losses amid some deterioration in risk appetite.  Further moves will depend on the progress towards a trade deal, with the USD likely to be pressured should it become clearer that a deal is likely to be signed and vice-versa.  US retail sales data will also have some impact in the short term, but with the Fed on pause and US data holding up the USD the will be driven by driven by the gyrations in risk assets.

Limited Relief

Now that the dust has settled on the US-China limited ‘Phase 1’ deal formulated at the end of last week markets can look to other events/data this week.  Prominent among these are Brexit discussions, which look as though they are carrying over to today as discussions towards a final deal intensify (more on this in another post).  However, casting a shadow over markets today is the news that China has threatened retaliation against the US after the House of Representatives passed a bill on reviewing the preferential treatment for HK.

Stepping back, regarding the trade deal it was probably the easiest one on the table from China’s perspective.  The US agreed to hold back on raising tariffs on $250bn of Chinese goods while China agreed to increase agricultural purchases and give limited access to its financial markets.

However, it was no “love fest”.  It is very narrowly focused, doesn’t role back previous tariffs, does little to change the growth narrative, nor does it deal with the tougher structural issues and enforcement mechanisms etc.  It is also vague on the Chinese currency, renminbi. In any case China had already highlighted and strongly hinted at increased agricultural purchases over recent weeks

Yes, there was some vague commitment to address intellectual property (IP) issues, something that hawks in the US administration have been pushing for but this is akin to closing the barn door after the horse has bolted. China has already tightened up IP regulations at home and in fact is now keen to protect its own IP so it has a big incentive to tighten up IP rules.

The US administration was probably more than happy to avoid another increase in tariffs on China given the desire not to fuel more market instability, growing focus on elections next year and to show some form of progress to take the attention away from the impeachment inquiries.  Implementation of the next tariffs round on December 15 is unclear but given the above it could be delayed or scrapped.  That would be more substantial progress.

Over the short term markets will be relieved that tensions on trade are not worsening though the passage of the bill on Hong Kong by the US House of Representatives threatens to increase tensions on another front.  The bottom line is that there is some breathing space on the trade front, with the President Trump stating that it may take up to five weeks to complete the deal.  Some form of signing may take place at the Apec Summit in Chile in mid-November.

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