Trump’s China Syndrome

APAC News, US China Phase One Trade Deal announced December 2019

Donald Trump announces latest resolution of the trade impasse between the world’s two biggest economies

14 December 2019 | Shane Oliver, AMP Capital

The announcement of an agreement between the US and China on a Phase 1 trade deal is good news. While some of the details are a bit vague, and the legal text has yet to be finalised and signed, it averts threatened December 15th tariff hikes and cuts the September tariff hike from 15% to 7.5%.

In return, China will make “substantial” additional purchases of US agriculture products; and lists progress in intellectual property protection, forced technology transfer and financial services.

President Trump said Phase 2 talks would begin immediately but whether that happens and what progress they make remains to be seen. In the meantime, the Phase 1 de-escalation is good news for now and takes some pressure off the global economy which makes it good news for commodity prices and Australia.

Geopolitical positives

The past week saw good news on the geopolitical front, in addition to the US and China Phase 1 trade deal. US Congressional agreement on the USMCA (NAFTA replacement), Congress averting another US Government shutdown from December 20th and the Conservatives with a big parliamentary majority in the UK’s election, were all positive market drivers.

This saw US shares gain 0.7%, Eurozone shares rise 0.8%, Japanese shares rise 2.9% and Chinese shares rise 1.7%. Australian shares rose 0.5% led by sharp gains in resources stocks helped by the positive news on trade but with falls in defensives and yield sensitive stocks. Reflecting the risk on tone bond yields were flat to up, commodity prices rose and the $A rose. 

The US Federal Reserve held monetary policy on hold with Fed Chair Powell remaining dovish, while being a bit more upbeat regarding unemployment. Our base case is for US interest rates to be on hold next year but with the risk of one more cut.

The Conservatives big UK election win will mean that PM Johnson’s Brexit deal with the EU will be signed, the UK will have a soft exit from the EU – which means leave but retain current trading arrangements –  by 31 January 2020 then enter into negotiations for a free trade deal.

These could still end in a hard exit if no free trade agreement is reached, but the threat of economic disruption will likely work against that particularly given that the UK will be officially out of the EU anyway and PM Johnson looks like he won’t be held back by hard line Brexiteers in the talks.

The avoidance of far left policies under a Labour Government is probably also a short-term positive for UK assets including shares and the British pound, although as always there is a risk of a near term “sell on the fact” pull back as markets had generally anticipated a Conservative victory.

Global economic movements

US economic data showed a rise in small business confidence, but weaker than expected November retail sales and core CPI inflation unchanged at 2.3% year-on-year.

Japanese September quarter GDP growth was revised up significantly thanks to stronger consumer spending and business investment. The December quarter Tankan was mixed with weaker manufacturing but strong services.

ECB President, Christine Lagarde’s first ECB meeting provided no surprises with an affirmation of, her predecessor, Mario Draghi’s stimulus program and a bit of confidence that growth may be bottoming.

Chinese data showed weaker than expected exports, but stronger than expected imports and credit. Inflation continued to rise on the back of higher food prices, but core inflation remains weak and producer price inflation is negative.

Australian confidence, and rates, are still low

In Australia economic confidence readings remain weak. Business conditions were unchanged in November and confidence fell slightly according to the NAB business survey and the Westpac/MI survey showed a fall back in consumer confidence and a continued focus on paying down debt.

The Australian Government’s Mid-Year Economic and Fiscal Outlook (MYEFO) is expected to show the budget on track for a decent surplus this financial year despite downwards revisions to growth and wages forecasts, thanks to higher iron ore prices and employment providing an offsetting boost to revenue.

Minimal new fiscal stimulus is expected to be announced beyond that which has already been flagged since the April Budget. The MYEFO is expected to show downwards revisions to the Government’s GDP growth forecasts for this financial year to 2.25% (from 2.75%) and a reduction in the wages forecast to 2.3% (from 2.75%).

This, along with weaker than forecast coal prices, will act as a drag on revenue growth but much higher than expected iron ore prices and higher employment are working in the opposite direction and so the surplus projection for this year may actually be revised up slightly to around $9.5 billion (from $7.1 billion) with subsequent years’ surplus projections expected to be little changed. This may provide some scope for additional fiscal stimulus to be announced in the May Budget focussed around bringing forward at least some of the already legislated 2022 personal income tax cuts.

However, the recent run of weak economic data does not appear to have been bad enough to move the Government to announce a significant new fiscal stimulus just yet. Rather the MYEFO is likely to emphasise the bring forward of infrastructure spending and extra drought assistance, although in total its small at just 0.1% of GDP for the year ahead.

Dr Shane Oliver is Head of Investment Strategy and Chief Economist at AMP Capital