After two months of breathless anticipation, investors received an early holiday present on December 13th when the U.S. and China signaled agreement on a “Phase One” trade deal. While it has yet to be signed and the exact details are still unknown, the broad outline includes: A) a commitment from China to purchase significantly more U.S. agriculture products, in exchange for B) the U.S. halving its 15% tariff on $120 billion of Chinese imports and postponing the next round of scheduled tariffs. In addition, the agreement includes somewhat vague commitments on intellectual property, technology transfers and currency manipulation. Harder issues that aim at the heart of Chinese industrial policy are left to be tackled in subsequent phases.
With a U.S. presidential election coming in 2020, what is China’s incentive for accepting this “trade truce” right now? Of course, preventing further escalation lessens the negative pressure on the Chinese economy and permits it to stabilize next year. However, there is a more immediate concern for the Chinese government: African swine fever (ASF). ASF has been ravaging China’s pigs since August 2018, with the disease shrinking China’s domestic pig herd by 40-50%. This is particularly important for China, which is the world’s largest pork consumer and used to produce almost all of its pork domestically. This drastic drop in supply even forced China to tap into its strategic pork reserve, but it has been insufficient to meet demand.
As a result, pork prices have surged in China this year, rising 110% year-over-year in November. This has driven overall consumer price inflation to 4.5% year-over-year, above the central bank’s 3% target. Excluding food, consumer prices are still subdued, rising only 1.0% year-over-year. While not an immediate reason for monetary tightening, this increase in food prices does raise some alarm bells for the Chinese government, especially as it has struggled to contain ASF and normalize pork supply for almost a year and a half.
In order to meet demand, China has been importing pork from around the world and has announced a cut in tariffs on frozen pork from all trading partners, effective January 1st. In fact, China has already been meaningfully increasing its imports from the U.S., the world’s largest pork exporter. According to the U.S. Census Bureau, China has gone from being the destination for 4% of U.S. pork in 2018 to 20% in October 2019.
As a result, China’s promise to purchase more U.S. agricultural products in 2020 is as much rooted in necessity as it is in goodwill. Tackling the tougher structural issues, however, do not look to be in the cards in the near term. As a result, investors should consider the “Phase One” deal an important victory for global economic stability in 2020, but not the end of the trade war.
China's pork prices have surged as a result of African swine feverWholesale pork price, CNY/kg, year-over-year % change
Source: Ministry of Agriculture and Rural Affairs of China, J.P. Morgan Asset Management.
Data are as of December 27, 2019.