Natixis IM: “Phase One” Trade Deal

Natixis IM: “Phase One” Trade Deal

China Verenigde Staten Handelsconflict
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By Esty Dwek, head of Global Market Strategy at Natixis IM

On Friday, the US and China agreed on a “Phase One” trade deal, that saw the 15 October tariffs suspended. Talks are expected to continue for a signature at the APEC summit in Chile in mid-November. Talks are also expect to continue for a “Phase Two” deal, though we do not expect a swift resolution on a broader agreement.

China has agreed to buy twice as many agricultural products from the US, who will suspend its 15 October tariff hike.  China also agreed to further open market access to financial services, continue discussions on intellectual property, and an ‘almost complete’ agreement on currency manipulation.

Technology was kept separate from this agreement, but we could see some improvements on this front for Huawei in the coming weeks, as negotiations are set to continue until the 17 November expiration of Huawei’s current general license.

We had been expecting this is the type of mini-deal, and it could lead to further progress at the APEC summit and the G20 meeting at the end of November.

Indeed, Mr. Trump needs to navigate the trade dispute carefully as data is pointing to some impact on the US economy, finally. As such, we expect the truce to last, and most likely the 15 December tariff hike to be suspended as well, though we do not expect the rollback of tariffs for some time.

What’s next?

“Phase two” could be discussed in the coming weeks and months, suggesting December tariffs are likely to be suspended as well, but we do not expect a grand agreement or a rollback of existing tariffs this year. Both sides remain far apart on many thornier issues and last week’s agreement really only reinforced actions China has already been taking.

For now though, both sides are likely happy and incentivized for this agreement to be the start of improving trade relations. Indeed, Mr. Trump needs a ‘win’ in the current context and given impeachment proceedings. He also needs to be careful to avoid too sharp a downturn in the US economy in his re-election year. Business sentiment and business investment have been suffering from the ongoing uncertainty.

For his part, Mr. Xi would like to see an easing of trade pressures on his economy, which continues to slow, and not give too many concessions in exchange. Most of what was agreed was already happening, but should help to limit tariff increases going forward. Indeed, given the ongoing Swine Flu, China needs more pork and has already been buying more.

We are likely to see an easing in trade tensions until the end of November, a welcome reprieve for markets. We could also see further gradual steps, but we still do not expect a broad trade agreement this year.

Investment implications

Equity markets rallied on the news, as expected by an easing in uncertainties. If the truce lasts until end of November, and they manage to halt the December tariff hike too, we should see ongoing support for markets.

The spotlight is likely to turn to the Q3 earnings season now. As expectations have been slashed (again), we could see better-than expected results help markets grind higher as well.

As market performance has already been strong so far this year, it should continue to be look at in the context of Q4 2018’s sharp fall. As such, there is room for upside if geopolitical uncertainties ease in the coming months. Next up is likely Brexit, where some encouraging headlines also appeared over the weekend.

Sovereign bond yields retreated on improved risk appetite, with the US 10-year yield rising to 1.72%, while the 10-year German Bund reached -0.47%. We do not expect a sharp back-up given low inflation and ongoing growth concerns, but yields could still drift higher.

The easing in trade tensions could mean the Federal Reserve can wait until December to cut interest rates again, though they may want to guarantee market support with a cut now and then pause longer if the trade truce lasts.

The dollar is likely to maintain underlying support, though it may not strengthen much more from here.