The US-China trade deal presents a paradox for markets
The US-China trade deal presents a paradox for markets
Weekly Market Compass: The Phase 1 deal doesn’t mean much, yet is also critical for sentiment.
Last week, the US and China signed their Phase 1 trade agreement. This trade deal is a paradox — in my view, it is both inconsequential and yet extremely important.
It is inconsequential for two reasons: Tariffs will remain in place on a large amount of goods traded between the US and China, and the deal doesn’t tackle many of the most important trade issues between the two countries. However, it is extremely important because of what it symbolizes: This trade deal suggests that friction between the two countries has peaked and is moving lower. The psychological effect is very significant, as it means that economic policy uncertainty has fallen. And, when companies believe economic policy is more certain, they typically spend more, especially on capex.
Some flies in the ointment
Now, there is a small chance this deal may not hold. I don’t believe China will be able to purchase US goods at the level it has committed to, based on its history of purchases as well as the deeper trading relationships it has formed with countries such as Brazil. And I believe that’s why the US has not rolled back many tariffs. In fact, it has been reported that the US will not roll back any more tariffs until after the US presidential election, and that a roll back would be contingent on China adhering to its commitments in the Phase 1 agreement. However, I think the Phase 1 deal will hold, regardless of whether all commitments are honored as it’s in the best interest of both parties.
I should also underscore that I do not expect a Phase 2 trade deal between the US and China to be signed this year. A Phase 1 deal was relatively easy to achieve because it tackled a lot of the low-hanging fruit — easier issues such as trade imbalances. Now that all the easy issues have been resolved, we have to expect that Phase 2 will be far more difficult to achieve.
Perhaps most sobering was a recent post in Taoran Notes (a blog affiliated with China’s official Economic Daily newspaper, which can reflect official government views). It cautioned that “We must bear in mind that the trade war is not over yet — the US hasn’t revoked its tariffs on China and China is still implementing its retaliatory measures. There are still many uncertainties down the road.”1 And so I believe that continued talks around Phase 2 are all we can hope for, and we are likely to see such talks — but it is highly unlikely that we get a deal. However, I think that the conversation will be enough to satisfy stocks.
Could a US-EU trade war be on the horizon?
There remains one key risk that I have worried about for a while: Now that the US has signed the trade deal with China, will it now turn its attention to the EU and escalate a trade war there? The tension between the two has been clearly building: Last week, the EU’s chief trade negotiator visited Washington, DC, in an attempt to avert US trade aggression toward the EU. And talks will continue on the sidelines of Davos this week. However, I believe there is a good chance of an escalation in trade tensions — this could be politically popular in an election year for the US, and I believe a trade war with the EU would be less damaging to the US economy than a trade war with China. However, it could be psychologically damaging to companies, raising economic policy uncertainty and tamping down capex spending. So we will want to follow the situation closely.
And so economic policy uncertainty has, for now, declined. I expect we will see capex spending increase. We are anecdotally hearing that Chinese household sentiment has turned much more positive in particular, which should be good for the Chinese economy and Chinese stocks. Chinese stocks could also continue to benefit from the end of balance sheet normalization, which occurred last September and is beginning to inject some liquidity into markets.
Kristina Hooper is Chief Global Market Strategist at Invesco.
^1 Source: South China Morning Post, Jan. 13, 2020
The opinions referenced above are those of Kristina Hooper as of Jan. 21, 2020.
This document has been prepared only for those persons to whom Invesco has provided it for informational purposes only. This document is not an offering of a financial product and is not intended for and should not be distributed to retail clients who are resident in jurisdiction where its distribution is not authorized or is unlawful. Circulation, disclosure, or dissemination of all or any part of this document to any person without the consent of Invesco is prohibited.
This document may contain statements that are not purely historical in nature but are "forward-looking statements", which are based on certain assumptions of future events. Forward-looking statements are based on information available on the date hereof, and Invesco does not assume any duty to update any forward-looking statement. Actual events may differ from those assumed. There can be no assurance that forward-looking statements, including any projected returns, will materialize or that actual market conditions and/or performance results will not be materially different or worse than those presented.
The information in this document has been prepared without taking into account any investor’s investment objectives, financial situation or particular needs. Before acting on the information the investor should consider its appropriateness having regard to their investment objectives, financial situation and needs.
You should note that this information:
• may contain references to amounts which are not in local currencies;
• may contain financial information which is not prepared in accordance with the laws or practices of your country of residence;
• may not address risks associated with investment in foreign currency denominated investments; and
• does not address local tax issues.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Investment involves risk. Please review all financial material carefully before investing. The opinions expressed are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
The distribution and offering of this document in certain jurisdictions may be restricted by law. Persons into whose possession this marketing material may come are required to inform themselves about and to comply with any relevant restrictions. This does not constitute an offer or solicitation by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation.