Last week negotiators from China met in Washington as part of a second round of in person discussions following a U.S. delegation’s visit to Beijing last week. Negotiations are ongoing this week as part of marathon talks to put an economically debilitating trade war to bed. By what we can tell, talks so far are going well.
To be sure, sentiment out of the White House suggests that the talks last week remained constructive and focused on key topics of the ongoing trade dispute, including IP, forced technology transfers, non-tariff barriers to trade, agriculture trade, services and enforcement according to a report from SCMP.
Similar progress was cited the week of March 29 when the U.S. delegation led by US Trade Representative Robert Lighthizer visited Beijing.
What matters to the markets?
What is of most concern for the markets now in our opinion is not whether a trade deal will get done, but when it does, will it be enough to support market prices at current levels. President Trump has been eager to get a trade deal finalized, but China hawks have been cautious about getting a deal done simply for the sake of moving beyond the uncertainty that the U.S.-China trade war has brought and the indirect impact it is having on both economies.
Therefore, the timeline for getting a trade deal done is still uncertain. While media representatives for the Trump and Xi administrations have been careful to position ongoing talks as positive, there has been notable hesitation to suggest that a deal will be inked anytime soon.
Risk assets have nevertheless pushed higher this year following a market rout late in the fourth quarter. A key catalyst for the rally has been the prospect of the conclusion to the U.S.-China Trade War brought on by these ongoing talks.
As markets continue pushing higher, media outlets keep pointing to positive news surrounding negotiations as a supportive catalyst for the rally. The issue that we see is that this explanation is likely to lose its efficacy in the coming weeks as the “deal coming soon” narrative becomes exhausted. Therefore, investors are likely to question what may be supportive of the current rally and a new bout of market volatility is likely to be on the horizon.
More market risks on the horizon
While the media’s explanation for the current rally has some merit, little new development from talks are able to justify continued market optimism likely to sustain higher prices. This is increasingly notable given that the global economy is in a slump and several important economies are facing the prospect of a recession (likely in Europe). Further, our work suggests that growth in the U.S. economy likely will weaken this year, and as a result the U.S. business cycle could roll over into a slowdown should growth come in line with our forecasts. These factors are negative for market sentiment.
A trade deal, when it is finally inked whether in the next few weeks or months could further dampen market sentiment depending on its final outcome. Given the historically complicated nature of trade negotiations, the type of document both Presidents will sign, whether that comes in the form of a non-biding Memorandum of Understanding (MoU) or official trade deal is still yet to be determined. The original incarnation of NAFTA was negotiated in the 1980’s and only went into effect in the 1990’s. The point being that durable deals take lots of work and lots of time.
Therefore, the deal agreed on by both parties could be disappointing once it is finally made public. A weak deal, therefore, may be received poorly by the markets as the U.S. administration’s hard charging effort at finally putting China, and the economic costs it has wrought was all for nothing.
Finally, the matter regarding tariffs remains outstanding. How and when the U.S. tariffs on $250bn of Chinese imports is rolled back is likely to be tied to the enforcement mechanism surrounding the trade deal. An MoU that paves the way toward a final agreement sometime next year would likely mean that tariffs remain in place, and this could further be a headwind to the global trade environment.
The risks of an escalating Trade War is in our view a key contributor what had dampened market and economic sentiment in the second half of 2018, likely having set the stage for a broad market selloff at the end of the year. These risks have abated recently as progress on talks remain “constructive”.
But the outlook on the global economy, including the U.S. has been downgraded and is now a sentiment headwind waiting in the wings. As a result, while markets have rallied on the trade news, the opacity of discussions and the fading optimism surrounding trade talks is increasingly leaving the sharp run up in market prices exposed to a disappointment when a deal is finally introduced.