“Talk Is Cheap”: Here Are The 3 Signals That A Real US-China Trade Deal Is Coming
Authored by Michael Zezas, Head of U.S. Public Policy Strategy at Morgan Stanley
The US and China are again talking about trade, and for the moment the mood has improved. Goodwill gestures have been exchanged to pave the way for October talks, most notably the US delay of an October 1 tariff increase until October 15 to avoid a conflict with the 70th anniversary of the foundation of the People’s Republic of China. Media reports suggest negotiators on both sides are actively exploring ‘mini-deals’ of various stripes – ways to limit further tariff escalation and perhaps even roll back some tariffs as negotiations continue. These talks are good news. After all, communication is key to breaking out of a ‘prisoner’s dilemma’, which is how we look at this tariff confrontation. Hence a further delay of October tariffs has become a real possibility, which could add up to a multi-month respite from trade escalation.
But talk is also cheap. As we’ve learned time and again throughout this negotiation process, compromise ideas that are floated can quickly be torpedoed. That’s a reflection of how complicated this process is, with both sides maintaining steadfast views on key issues like enforcement and how quickly existing tariffs should be removed. So as news breaks around these talks, it’s important to separate the signal from the noise: Which headlines will tell us an economically meaningful ‘real deal’ is possible, and which will not?
Let’s focus on what would suggest that a ‘real deal’ that investors should care about is coming together. The test for us is whether or not any arrangement in the coming weeks meets the threshold of a ‘durable pause’ in tariff escalations. All three prior pauses have been followed by re-escalation of trade tariffs, so something would have to be viewed as different this time to interrupt the cycle of sagging corporate confidence, falling capex, and labor weakness that our economists think is in motion.
What could signal that something is different? A meaningful concession, likely preceded by one of three circuit breakers:
- obvious weakness in risk assets,
- obvious weakness in economic data, and
- an obvious increase in political risk.
Any of these would create incentives for one or both sides to make concessions on core issues. For example, we think a positive headline about a meaningful agreement on the issue of trade deal enforcement – not just a ‘conceptual’ agreement, as Secretary Mnuchin put it – would be an obvious sign that one of these thresholds had already been met.
So far, it doesn’t seem to us that any of these signals have appeared. In all the media discussion of mini-deals and US/China government comments over the last week, nowhere did we see statements indicating that the enforcement or other key issues were close to being resolved.
This seems consistent with a lack of evidence that any of the circuit breakers have been tripped: Equity markets have remained at high levels; polling numbers for the US president have not dropped any further in recent months; and the economic data remains mixed in both countries. True, the media has reported US administration advisors have become increasingly concerned about the economy and re-election, but those same reports are careful to note that the President does not necessarily share those views. This is a critical distinction.
Hence we expect more ‘cheap talk’ than ‘real deal’. Until one of those circuit breakers is tripped, negotiators will be left to look for an arrangement that freezes tensions without compromising either side’s core views. This will be difficult to achieve. Consider for example last week’s Bloomberg report that US administration advisors were contemplating an offer to remove September tariffs and freeze further tariffs in return for more agricultural purchases and some type of commitment on IP reforms. Yet only minutes later, the White House denied it was considering any such deal. That shouldn’t surprise followers of these negotiations, given the complexity of arrangements that satisfy both sides on issues like IP. This underscores the core issue: Little progress has been made on how to resolve key issues, like enforcing a deal.
So what should investors expect? Plenty of swings in sentiment, but a trend toward escalation until markets, the economy, or politics clearly intervene.
For today, that means some value in tactically risk-positive trades like bund steepeners and EM currencies, markets where sentiment arguably has gotten too bearish. But unless those trade circuit breakers are tripped in the coming months, we’d expect the announced tariffs to eventually take effect (even as another delay of the upcoming October 15th tariffs remains a distinct possibility), keeping pressure on risk assets over the medium term. We’ll naturally be watching closely and reporting back to you.
Enjoy your Sunday.
Sun, 09/15/2019 – 18:10