When, not if. The on-again off-again US-China deal

US China trade deal is in the interests of all to get done

with china it’s biggest market US agricultural exports are a key element of any trade deal

Ultimately a US-China trade deal is in all parties’ interests and the pressure is rising to get it done

16 November 2019 | Shane Oliver, AMP Capital

The past week initially saw some cautiousness creep back into share markets with uncertainty about a US-China trade deal, but this gave way to renewed optimism by the end of the week. There was a bit of ‘argy-bargy’ but pressure on the US and China to make a trade deal remains immense and it looks to be getting close.

Uncertainty on the trade front ramped up earlier over the last week around Chinese agricultural purchases and a roll back in tariffs and comments by President Trump threatening to raise tariffs substantially if they don’t make a deal but that a trade agreement is “moving along very rapidly…China wants to make a deal” added to the uncertainty.

However, there are several things to note. First the Phase One deal was never meant to be a complete break through – just an easing in tensions with easy to do measures like Chinese agricultural purchases, a cancellation of the scheduled December 15 tariff hike and maybe some of the September tariff hikes and some sort of commitment to reaching further agreement on trade issues.

Impetus for a deal

Second the pressure on both sides to ease tensions is immense. Trump wants good news to help the economy hold up ahead of the Presidential election and to offset the impeachment. Going through with the scheduled December 15 tariff hike on a range of consumer goods would be shooting himself in the foot.

For China, given the ongoing slowing in its economy and its need for some US agricultural products it makes sense for it to cut a deal now. No immediate deal could mean China running the risk of waiting till after the election when they could find an even tougher Trump or, Democratic presidential candidate, Elizabeth Warren to deal with.

Finally, comments by White House economic advisor Larry Kudlow that “we’re getting close… (and) the mood music is pretty good”; plus further comments by Commerce Secretary Wilbur Ross that “we’re down to the last details now… (and) that there’ll be a deal in all likelihood” suggests a Phase One deal may be close, although the final stages of trade talks are often the hardest.

Market movements

These movements saw US shares rise 0.9% for the week to a new high and Eurozone shares gain 0.3%. However, Japanese shares fell 0.4% and Chinese shares fell 2.4%. Australian shares rose by 1% as market expectations for an RBA rate cut rebounded and defensive or yield sensitive sectors like health, consumer staples and real estate rose strongly.

Australian shares are now just 1.2% away from a record high. Bond yields fell as did metal prices, but oil and iron ore prices rose. The Australian dollar fell as expectations for further RBA rate cuts increased again.

Australian employment and wage growth remains stalled

Weak jobs data and slowing wages growth highlights that Australia still needs more policy stimulus. Economic growth is likely to remain below potential so unemployment, underemployment and spare capacity will remain relatively high and this will continue to result in weak wages growth and inflation.

Ideally fiscal stimulus – in the form of faster tax cuts, a boost to Newstart, investment incentives and a bring forward of infrastructure spending where possible – is needed from here. The government’s 15% tax break for infrastructure projects and comments by Treasurer Frydenberg that “we’re always looking for opportunities to reduce taxes” which holds out the hope of accelerated personal tax cuts are welcome.

But it’s unclear that fiscal stimulus will be enough or come quickly enough, particularly with the Government still primarily focussed on safeguarding the surplus. In the absence of significant fiscal stimulus soon the pressure remains on the RBA where we expect to see further monetary stimulus in the form of rate cuts down to 0.25%, quantitative easing (possibly designed to lower bank funding costs and allow banks to pass on more of rate cuts) and more dovish forward guidance on rates.

Further monetary easing will no doubt fuel further gains in Sydney and Melbourne house prices (which is another reason why fiscal stimulus is preferred!). However, the RBA has to set monetary policy for the average of Australia and not just two cities. This probably means that we should expect a renewed tightening of bank lending standards next year.

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