US and China signal temporary de-escalation in trade conflict

Thought of the day

by Chief Investment Office 03 Dec 2018

What happened?
A pivotal meeting between the US and Chinese presidents has ended with an easing of tensions over trade and a commitment to further negotiations. The White House said it was willing to delay a 1 January increase in tariffs on USD 200bn of Chinese goods, from 10% to 25%, while negotiations continue. In return, China agreed to purchase a "very substantial" amount of US farm, energy and industrial goods. Talks will begin over intellectual property theft and the forced transfer of technology, with a three-month deadline. Failure to agree terms will result in a renewed rise in US tariffs on Chinese goods, the White House indicated.

At this time, markets view the news as modestly positive for risk assets. Global equities rallied late last week on optimistic signs for the US-China meeting and the perception that the US Federal Reserve is becoming more flexible about rate hikes.

In other G20 news, there were more indications that OPEC and Russia will co-operate to stem the recent slide in crude oil prices. An agreement to replace NAFTA was also signed, though it will now need to be ratified by the legislatures in the US, Canada and Mexico. Finally, US markets and the federal government will close on 5 December in observance of a National Day of Mourning for former US President George H.W. Bush, who died on 30 November at the age of 94.

What does this mean for investors?
While President Donald Trump described the bilateral meeting with China as "amazing and productive," we believe the rivalry between the US and China will not be easily overcome, especially when it comes to the issue of intellectual property and market access. A breakdown of talks remains a risk for markets and the global economy. US trade relations with other partners also are still tense, and we will keep abreast of the White House threat to impose more tariffs on car imports, which would constitute a significant headwind for the large German and Japanese auto sectors.

However, the delay in the tariff rate increase is a positive development relative to our base case, and the meeting managed to avert a significant escalation that could have deepened the recent sell-off in global equities. A negative outcome could have included the swift imposition of a third round of US tariffs on an additional USD 267bn worth of Chinese goods. This further round of tariffs would have targeted China's higher value-added IT products and inflicted greater disruption on global supply chains.

What does this mean for our positioning?
The outcome of the G20 meeting supports our moderate risk-on stance. We added to our overweight in global equities after November's US mid-term election based on the view that markets had adjusted to better reflect concerns over slower economic growth and the escalation of the trade conflict. In the past week we have learned that both the Trump administration and the Fed are not dogmatically pursuing policies without regard to their market and economic impacts. We remain overweight global equities and US dollar-denominated emerging market sovereign bonds. Yet we also still expect heightened volatility related to policy and economic news. As a result, our equity overweight is balanced with counter-cyclical positions – including an overweight on 10-year US Treasuries and the Japanese yen versus the Taiwanese dollar.

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