Should investors still worry about U.S.-China trade?
The U.S. and Chinese governments gave markets an early Christmas present when they agreed to a partial trade deal. However, much like prior twists and turns in this trade war, whether or not markets remain enthusiastic about this present will depend on the details and whether or not policymakers press ahead on negotiating the remaining outstanding issues.
Last week, the U.S. and China announced what U.S. policymakers are calling a ‘Phase One’ trade deal. This agreement postpones the U.S.’s threatened next round of tariffs on imports from China. Recall, the U.S. was due to apply 15% tariffs on USD 156billion of imports from China on December 15. With those tariffs in place, the U.S. would have been applying tariffs ranging from 15% to 25% on almost all imports from China under its Sec. 301 action.
In 2017, the U.S. initiated a Sec. 301 (a U.S. trade law that allows the government to investigate and punish unfair competition) probe to look into China’s treatment of intellectual property. As a result of the U.S.’s findings, it has been applying higher and higher tariffs covering most imports from China. Various arms of the U.S. government have also stepped up their scrutiny of Chinese companies’ activities and investment in the U.S. China has retaliated in kind, with tariffs covering nearly all of its imports from the U.S. Additionally, U.S. companies operating in China have reported a more difficult operating environment as a result of these trade tensions.
Negotiations about scaling back these measures have moved in fits and starts. Every time policymakers have seemed close to a deal in recent months, the deal seems to have fallen apart at the last minute. Days before the latest round of tariffs were scheduled to go into effect, policymakers announced a ‘Phase One’ deal. The intent behind this phrasing is to indicate that many issues remain unresolved and that the U.S. and China will resume negotiations in the near future.
‘Phase One’ entails the U.S. suspending the next round of tariffs (15% on USD 156billion) and cutting the tariff rate on the September 1 tranche of imports in half (15% on USD 125billion will now be tariffed at 7.5%) in exchange for China committing to purchasing USD 50billion of U.S. agricultural products annually, among other changes. The agreement that U.S. President Donald Trump and Chinese President Xi Jinping will sign—theoretically in January—also contains provisions on intellectual property, technology transfers, non-tariff barriers to agricultural trade, access to China for U.S. financial services firms, currency, trade promotion, and dispute resolution. Few details on these matters have emerged beyond the high level overview the U.S. side has shared with the press.
News of a trade deal, even a partial one, cheered markets
EXHIBIT 1: EQUITY MARKET REACTION TO U.S.-CHINA TRADE DEVELOPMENTS
S&P 500 AND CSI 300 PRICE INDEX, REBASED 01/01/19 = 100, IMPORTANT DEVELOPMENTS IN TRADE WAR ANNOTATED
For investors, those details will matter a great deal. As we have long highlighted, the U.S.-China trade war extends far beyond the tariff rate on imports from the other. Questions over market access and how integrated these economies and financial systems should be represent the heavy lifting in negotiations. This ‘Phase One’ deal is encouraging as it represents some progress on these issues.
Investors may interpret this announcement a signal that they can cross trade off their list of worries in 2020. In the near term, this deal does widen the band for risk tolerance in equity markets. However, in our view, dismissing trade as a worry would be a mistake. Many outstanding issues remain on the table, and it would be foolish to assume that policymakers will just let these issues rest until a more opportune political time. Even if all measures to restrict trade were left on hold throughout 2020, U.S. tariffs on Chinese imports would still be six times higher than they were before the trade war. So long as markets realize this issue will continue to unfold throughout 2020, progress toward a trade deal can be interpreted as a cautiously optimistic signal.