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The White House is set to announce whether it will postpone the next round of tariffs on China, with President Trump tweeting moments ago that a phase one deal is “very close”. Even if this deal isn’t reached by Sunday, when the new tariffs are set to kick in, Trump is still likely to postpone them in order to keep the negotiations going. It seems very unlikely at this stage that he would pull the trigger on the new tariffs, but this is Trump we are talking about, so nothing is certain. In the bigger picture, even if a ‘skinny’ deal is reached soon, it’s difficult to envision any progress after that.
An offer you can(not) refuse?
Hopes that the US and China would reach a phase one deal soon came roaring back today, after the American President tweeted that such an agreement is very close, propelling stock markets to new record highs and pushing haven assets like the yen and gold lower.
The sticking points so far in this ‘phase one’ negotiation have been the size of agricultural purchases that Beijing is willing to commit to, and how quickly the existing tariffs will be rolled back. Washington wants concrete pledges that China won’t stop or reduce its farming purchases in the future, while China is demanding that the US cancels its upcoming tariffs and also rolls back its existing ones.
According to the latest reports, Trump offered to cancel the upcoming tariffs and roll back the existing ones by 50%. In exchange, the US wants firm commitments that China will honor its agricultural purchases, protect intellectual property rights, and open up its financial sector. It’s still unclear whether these are acceptable for Beijing, but for investors, the important part is that Trump ‘blinked’.
By softening his stance a little, he signaled that he probably won’t fire another volley of tariffs on Sunday, calming markets. Rolling back tariffs was something American negotiators resisted so far, on fears that it would reduce their negotiating leverage, so this is a significant development.
It’s also crucial to note that the upcoming batch of tariffs would probably hurt the US economy much more than the previous ones. Many of the targeted goods are core consumer products, from phones to laptops to clothing, so the impact on consumption could be severe. There’s good reason why these products have escaped tariffs so far.
This is especially important when factoring in next year’s US election. Imposing tariffs that hurt the US economy is probably the last thing Trump wants, as a weak economy certainly doesn’t help Presidents get re-elected. At the same time, he needs a ‘victory’ to present to the electorate before he hits the campaign trail – especially to his farmer supporters in crucial battleground states, who have taken a major hit from the trade war and are eagerly hoping China starts buying their agricultural products again.
Hence, most factors argue for Trump to postpone the next round of tariffs, even if a deal isn’t reached by Sunday. But one can never be certain with the US President. Beijing seems reluctant to sign up, perhaps on concerns that handing Trump a ‘trade victory’ on a silver platter might boost his re-election chances. It could also be that China wants some tweaks to the current offer, which may be a step too far for Trump.
To quote his own book: “The worst thing you can possibly do in a deal is seem desperate to make it. That makes the other guy smell blood, and then you’re dead.”
At this stage, the two most likely outcomes are either a ‘phase one’ deal being reached by Sunday, or Trump postponing these tariffs. In case a deal is reached, that would be the most positive outcome for global risk appetite. Stock markets could extend their latest gains alongside commodity currencies such as the aussie, while haven assets like the yen and gold may remain under selling pressure. Having said that, all these reactions may be relatively modest in scale, as markets have already priced in much of this cheery narrative.
Taking a technical look at dollar/yen, a potential deal could push the pair to the 109.60 region, where an upside break may open the door for a test of 110.70.
If on the other hand a deal isn’t reached, but Trump postpones the upcoming tariffs to keep the talks alive, that could prove mildly negative for risk sentiment. Stocks could give back some of their gains as the yen recovers a little ground, but these moves will probably be minor.
On the contrary, if the tariffs do go ahead, that would be a shocker for markets. Ergo, the risk-off reaction that would ensue may be much greater. Stocks could drop substantially while the yen skyrockets, as investors reassess the whole outlook for trade and brace for China’s retaliation. In this case, dollar/yen could break below 108.40 and if the bears pierce under 107.85 as well, their next target may be the 106.75 territory.
No real end in sight
In the bigger picture, it’s difficult to be optimistic that we will see any further progress beyond ‘phase one’. The two sides have spent two months now trying to sort out the simplest of issues, namely the size of agricultural purchases and a timeline for rolling back tariffs, and we still haven’t gotten there.
If it’s been so difficult to find common ground on these topics, how are they ever going to reach a consensus on the much more complex issues, such as industrial subsidies and intellectual property protection, which will be discussed in the second phase?
For investors, the implication is that the trade drama is not going away anytime soon – definitely not next year. Stock markets didn’t care much in 2019, mainly because the immense monetary stimulus from the Fed, ECB, and other major central banks was enough to eclipse the horrors of the trade war and inflate asset prices.
However, will 2020 follow the same pattern? Most central banks besides the Fed are already near their limits, having cut rates to zero or negative. And while the markets may still cheer a ‘phase one’ deal when it comes, that accord will probably do next to nothing to stimulate global growth, given how much uncertainty will remain about phase two and beyond.
Remember, in the world of trade negotiations, ‘nothing is agreed until everything is agreed’.AUDUSDgoldUS500USDJPY
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