Is the U.S.-China trade war over?
The U.S. and China signed a “Phase One” trade deal earlier this week. This deal has been presented as a way to halt the rising trade tensions between these two countries, but U.S. nor Chinese tariffs on the others’ goods are reverting back to their pre-trade war levels and American business complain of permanent loss of market share in China. Policymakers on both sides of the Pacific have been careful to emphasize that they view their work as incomplete and that several issues remain un-addressed.
Phase One
Shortly after taking office, U.S. President Donald Trump announced his administration would be taking a Sec. 301 action against China. Sec. 301 has become the popular shorthand for Section 301 of the Trade Act of 1974, which gives the President of the United States the authority to investigate suspected unfair treatment of U.S. businesses abroad and then apply tariffs in response to a finding of unfair competition. Since this report, the U.S. and China have been engaged in a two-year cycle of raising tariffs, pauses in further escalation while policymakers tried to reach a deal, only for talks to end acrimoniously and tariffs hikes to resume. This cycle of trade tensions hurt business confidence in both the U.S. and China, resulting in companies delaying or cancelling investment projects and introduced a great deal of trade-linked volatility into markets.
Altogether, the average U.S. tariff on imports from China has risen from 3.1% in January 2018 to 20.9%. China’s average tariff on U.S. imports has risen from 8.0% to 20.9% over the same period of time as China has responded to U.S. tariffs with its own increases, in addition to greater non-tariff restrictions on trade.
On January 15, the U.S. and China signed what they are calling a “Phase One” trade deal. This agreement entails the U.S. suspending its next planned round of tariffs, un-designating China a currency manipulator, and cutting the existing tariff rate on several goods from 15% to 7.5%. In exchange China will boost its imports from the U.S. by roughly USD 200billion over the next two years, allow greater access to its markets for financial services firms, enforce intellectual property protections, and be more transparent in its currency management practices (Exhibit 1).
EXHIBIT 1: The details of a Phase One deal
U.S.-China Phase One Trade Deal
Source: United States International Trade Commission, United States Trade Representative, J.P. Morgan Asset Management.
Data reflect most recently available as of 16/01/20.
This deal leaves several core disputes between these countries unsolved, most notably China’s industrial strategy. Policymakers have been careful in emphasizing that they plan to continue negotiations on these and other issues, hopefully paired with further reductions in tariffs, in the near future. Skepticism over whether or not these negotiations make any progress this year is warranted, as U.S. officials likely want a lengthy period to monitor China’s compliance with phase one, before moving to phase two.
Investment implications
This reduction in tariffs is likely less than Chinese policymakers were hoping. U.S. officials have hinted they do not plan to reduce tariffs any further until after the 2020 election in November. The most hawkish U.S. officials are also reportedly disappointed that Chinese subsidies for key industries were not addressed. Most importantly from our perspective, this deal largely encompasses what markets were expecting a trade deal this year to be. Risk asset prices have responded accordingly since this deal was announced.
However, in our view, investors should not assume that U.S.-China trade tensions have gone away completely. In addition to the several areas of debate left for a “Phase Two” deal, highly sensitive issues like the U.S.’s export ban to several Chinese companies, increased scrutiny on Chinese investments abroad, and China’s application of its commitment to treat foreign and domestic business alike within China are likely to make headlines throughout the year. For investors, these issues mean that markets will likely continue to price in an elevated risk premium, which could be a source of volatility throughout 2020.
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