Trade war déjà vu is scant comfort to investors

Beset by slowing domestic economies and under pressure to end a damaging trade war, Xi Jinping and Donald Trump struck a compromise to at least avoid inflicting more pain for the time being. The only problem is, we have been here before. Exactly the same narrative was offered in December 2018 when the two sides declared a truce, and here we are again. We do not think this truce will prove any more lasting.

At this point the deal is verbal only and the details are few; in some cases we must rely on President Trump’s word regarding Chinese commitments. Still, as in December of last year, the US has agreed to suspend an escalation of tariffs in exchange for Chinese promises of agricultural goods purchases, measures on intellectual property, currency and financial services.

Unfortunately, in another similarity with last year, there is no word on an enforcement mechanism. Given this was an issue ultimately credited with blowing up talks earlier this year and seeing the re-escalation of the trade war in May, this seems significant.

From the Chinese perspective, this does not deliver the ideal scenario of complete tariff rollback, but it is not a costly deal. The country needs more food supplies, with food price inflation soaring, so it is barely a concession. Similarly, financial opening is underway in any event, so this is again not really a concession. Other than that, they have bought a couple of months, at least, of breathing room with no escalation of tariffs.

December, when the next tariff escalation is still due, may be a crunch point. We suspect the Chinese are also looking ahead in the US political calendar and calculating that as President Trump becomes bogged down in fighting not just impeachment but another election, his ability to fight a trade war might be diminished. Increasingly desperate, he might cave on key demands around forced technology transfer and industrial policy. Of course, he might also lash out and seek to rally the base with a renewed assault on a foreign enemy. But better to have those tariffs imposed with a few months’ delay than immediately.

From the US side, this appears less strategically sound. It may reduce the pain for domestic firms and consumers marginally but recall that existing tariffs are still firmly in place. Perhaps it can be spun as a political victory at a time of growing problems for the president. Otherwise it looks like reducing leverage at a key moment.

What next?

As to what comes next, there are two dates to watch. The first is the APEC meeting between Trump and Xi, by which time this deal should be written down and finalised, ready for official endorsement. The second is the 15 December deadline for new tariffs of 15% on around $160 billion of goods. Given the tendency of these talks to fall apart once undertakings must be committed to in writing, we are sceptical that this deal survives to the end of the year. We still expect, as a result, re-escalation before year end, though it is possible the deadline for tariffs is pushed into the first quarter of next year.

What will the impact be for global growth?

Keith Wade, Schroders' chief economist says: 

The announcement of a first phase trade deal between the US and China must be welcomed, but can only have a limited effect on global growth. There will be a boost to US farmers as China buys more pork and soybeans, but otherwise all we have at this stage is a postponement of this week’s proposed tariff increase from 25% to 30%. The US is still planning a new 15% tariff on 15 December. This may also be delayed as part of a deal at the APEC conference on 16/17 November which will no doubt be heralded as a breakthrough.

However, as far as business is concerned, uncertainty will persist as tariffs remain in place and the threat of further increases will be used as a bargaining tool in driving a more important deal in intellectual property. China may decide it has conceded all it can and might allow talks to stall as the US presidential election ramps up. This would create a limbo for business which would weigh on capital spending as firms wait for greater clarity before making major spending commitments.   The tech war is likely to continue as security concerns remain high.

Meanwhile, we could also see a new front opening up in capital markets with the US restricting capital flows with China through restricting IPOs or institutional investment overseas. The first phase deal is a step in the right direction, but many more will be needed to lift the trade war fog.