17 October 2019
Following months of a trade stand-off, the US and China have agreed to a phase one trade deal. GAM Investments’ Rob Mumford believes the deal is a positive step in curbing a negative slide in the relationship between the two economic giants, as well as capping the associated global growth and recession risks.
The US and China have mutually agreed in principle to a phase one trade deal which spans a range of issues concerning trade and broader economic and industrial policy. The goal is to formalise an agreement over the next three to five weeks with the potential for a signing ceremony at the Asia-Pacific Economic Cooperation (APEC) summit in Chile over 16-17 November 2019. If successful, discussions regarding a phase two agreement are expected to start soon afterwards which will include matters not covered in this initial deal.
The key issues agreed in principle involve the delay to an imminent hike in tariffs (however not including the further escalations due in December), a step up in China purchasing US agricultural goods, aspects of technology transfer, intellectual property (IP) protection, working on a dispute mechanism and a move to a more transparent currency regime.
We feel the pronouncements so far, which the Chinese camp have not called an agreement but rather ‘substantial progress’, are more notable for what is excluded (for example issues around Huawei) and the vagueness of what in theory has been agreed than concrete progress for a sustainable improvement in the US-China relationship. However, from a market perspective, the deal is a significant positive as it at least temporarily halts the negative slide in this relationship and the associated negative implications for global growth and recession risk. The alternative was a continued ratcheting up in the number of areas of strategic conflict which recently included a threat from the Trump administration towards the restriction of Chinese companies from the US capital markets, adding yet a new front to the conflict which had already moved beyond trade into multiple other spheres.
This is the light trade deal a number were expecting after the leaders met at the June G20 in Japan and agreed to talks during July. In August, however, the US imposed new tariffs on the last USD 300 billion of Chinese exports and labelled China a currency manipulator with the renminbi moving through the RMB 7 threshold. This potential agreement has likely come now following a very worrying set of recent economic activity indicators, most notably US yields (and curve shifts) and the recent US Institute of Supply Management (ISM) manufacturing data. Chinese domestic data, meanwhile, has also been subdued and under pressure particularly in trade and manufacturing, although helped to some extent by the ongoing subtle easing in interest rate policy, fiscal support and industrial policy (including consumption stimulus and likely upcoming increased infrastructure spending).
Equity markets have had a muted positive reaction so far with various Chinese indices up 0.5-1% on the day the trade deal was announced, while Chinese US-listed American Depository Receipts (ADRs) moved sharply higher due to a less imminent threat to their listing status. The renminbi firmed, moving to the stronger end of its range since August, of 7.05 to 7.20 with renminbi 12-month forwards trading at 7.11 (implying a stable FX backdrop). China treasury rates have also firmed since their bottom in August with China 10-year government bonds trading just north of their 3.00-3.15% range of recent months.
There is a risk to even these light terms being ratified with both domestic US pressure and high level Chinese government meetings due at the end of the month presenting potential hurdles. However, we would expect a deal to be ratified given the terms described so far fulfil a number of pledges that the Chinese government had already been planning or are working on (eg a desire to maintain a stable currency, a new foreign investment law, a trend towards improved IP protection and even increased US agricultural purchases may be helpful given the recent increase in food price inflation). At the same time, the US administration is likely to be equally concerned about data trends and the role of this trade dispute as a driver of those trends, while the agricultural terms generate an electoral plus mark which will be the priority heading into next year’s elections.
What the Chinese government craves as much as anything is a stable external environment, in our view. There is plenty of structural growth and (conventional) policy firepower to use structural adjustments (like interest rate and tax reform) to manage, support and improve the quality of domestic growth while excessive external pressures pose risks to that process. This is a key theme for the equity market which also reflects the ‘premium growth with improving quality’ theme and trades at attractive valuations. In our view, China equities should continue to perform well assuming that tail risks can be avoided including doomsday scenarios for the future relationship between the US and China.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.