In the spirit of something is better than nothing, optimism that the U.S. and China can sign a partial trade deal by mid-November is rising, even amid growing acknowledgment that the relationship between the two economic powerhouses has changed and friction is likely to persist.
Comments from both sides are contributing to the hope. Over the weekend, Liu He, China’s vice premier and lead trade negotiator, noted substantial progress in the latest negotiations and vowed to keep dialogue going. And White House officials offered similarly upbeat comments about the prospect that President Donald Trump and China’s Xi Jinping could sign something when they meet at the Asia-Pacific Economic Cooperation summit in mid-November.
A signed, formal agreement would build on the rough outline of a pact that Trump and Liu announced earlier this month, when the U.S. agreed not to impose a round of tariffs that had been due to take effect Oct. 15, and China promised to buy more U.S. farm goods.
“When there is a will, there is a deal,” said IMF managing director Kristalina Georgieva at a press briefing last week, reflecting the glass- half-full view voiced by central bankers and finance ministers at last week’s annual meetings of the International Monetary Fund and World Bank.
Part of the optimism comes from the view that the alternative is scary. Central bankers and finance ministers at the meetings repeatedly identified trade uncertainty as the biggest risk looming over the global economy—saying it is unlikely to abate unless the U.S. and China reach a comprehensive and enforceable deal. If the tariffs that the U.S. suspended this month, and those it has threatened to impose in December, are implemented, the IMF estimates, the levies in total could shave 0.8% from global economic growth by the end of 2020. That would mean $700 billion less economic output.
The path to the type of deal that would lift the uncertainty isn’t an easy one. “If we sign a deal, the U.S. should lift all tariffs imposed on China since March 2018,” said Zhu Min, director of the National Institute of Financial Research at Tsinghua University and a former vice president of the IMF, on a panel at the meetings last week. “The second issue is that the U.S. named China a currency manipulator, which was unfounded. IMF has said China isn’t an exchange-rate manipulator so the U.S. [has] to change its tone. These are very fundamental issues for us to move to the table to sign the deal.”
Others worry that the phased deal on the table doesn’t address some of the core issues at the heart of the trade war, such as China’s subsidies to its companies and intellectual-property protection for the digital age.
But markets could still find temporary relief in any sort of deal. “Those looking at the deal and saying it didn’t address some of the core issues outlined by the Trump administration are setting too high a bar,” Andy Rothman, investment strategist at Matthews Asia, told Barron’s. “I’ll be ecstatic just to get back to where we were two years ago, so companies can get back to business and families don’t have to pay higher taxes” in the form of tariffs.
Rothman expects some sort of a deal will be signed in November.
What is being discussed in this phase of talks are relatively easy concessions for the Chinese. Moves to protect intellectual property around trademarks and increased market access, for example, are in the interest of its own economy as it tries to rely more on innovation, Rothman added.
Indeed, some of the reforms the U.S. is asking for are needed for China to achieve long-term sustainable growth—Beijing’s primary focus, even in light of the trade war, Min said. China’s economy is growing at its slowest pace in decades, though data out in September showed some signs of stabilization.
The challenge for China—one that other emerging markets have faced in the past—is to not get stuck in the so-called middle-income trap, unable to transition from a phase where it averages $10,000 per capita in income to one with an average of $15,000 or more. “If China wants to get into the high-income category, it has to do lot of reform, open up and digitization,” Min said. Improving productivity is key and opening markets to competition is a way to achieve it, he said.
China recently set a timetable to open up its financial services sector. It is likely to keep dialogue open to increase its presence on the global stage—even as friction on other matters intensifies.
And frictions are likely to intensify. The U.S. House of Representatives recently approved bills in support of the Hong Kong protesters—a move that Charlene Barshefsky, a partner at WilmerHale and former U.S. trade representative, said on a panel Friday at the Council on Foreign Relations would likely be viewed by the Chinese as a provocation “of serious sort.” The move complicates China’s relationship with the U.S. and the political situation for Xi internally, she said.
But the legislation is unlikely to derail a trade truce—and could even help. “Trade is the easiest [issue for Xi] to fix at this juncture, especially with a phase one agreement,” Barshevsky said.
Lifting tariffs and signing a partial deal could improve sentiment toward Chinese stocks, according to Matthews Asia’s Rothman. “Valuations are inexpensive and a lot of people are on the sidelines waiting to get into China,” he said. “Then, in the months after the deal, the question will be if the administration continues to pursue a strategy of decoupling and containment, or if the president instead refocuses on engagement. I put the chances there at 50/50.”
The iShares MSCI China ETF (MCHI) is up 10% so far this year but has fallen 3% in the last three months.
One bump in the road could come this week when Vice President Mike Pence is expected to deliver a speech on China. In a talk last year, Pence warned of a new approach, making it clear message that “This president won’t back down.”
That speech, along with steps to restrict exports to Chinese companies such as Huawei Technologies, and increased scrutiny on investments, fed the longer-term view that the U.S.-China strategic competition is going to persist. That is a key concern among longer-term asset allocators.
Pascal Blanqué, global chief investment officer of Amundi, which oversees nearly €1.5 trillion ($1.67 trillion) in assets, said in an interview he is still cautious about emerging markets broadly. He sees the potential for a new phase of globalization where global growth isn’t synonymous with global trade and companies retreat from the world stage to their homes or their regions.
The takeaway is that volatility is likely to ensue. A partial deal, signed in November, could lift the market, but longer-term investors may still need to rethink their portfolios for a world where U.S.-China frictions become the new normal.
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