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.