Mid-week Commentary: What comes after the pause?

The 18-month long feud between the US and China went into official ceasefire mode as President Trump and Chinese Vice Premier Liu He signed an initial agreement yesterday afternoon, which would boost Chinese purchases of US manufactured and agricultural goods, energy and services. 

This ‘Phase One’ deal may have eased concerns about the economy, if not markets which are at all-time highs on constant ‘trade war optimism’, as the conflict between the world’s two largest economies hit hundreds of billions of dollars in goods and slowed economic growth. The bulk of the deal was known in advance, so markets barely moved but at least the downside risk of a never-ending escalation of tariffshas been removed. 

However, the modest scale of the rollback of existing tariffs means that the deal provides little boost to US GDP growth this year. In effect, the US-China trade relationship is still in a worse state now than when President Trump took office. Two years ago, the average Chinese tariff on US imports was 8%, the average US tariff on Chinese imports 3%. Today, these levels on both sides sit at around 20%. 

Aside from the improbable increases in Chinese purchases which we highlighted in the Week Ahead, there are still many questions to be answered. Could it be that once the immediate pork and swine shortage is addressed, China’s need for US agricultural products will subside? The US may also find that market access for banks and credit card companies may not quite be what it thought, in a market which is already quite mature. 

Going forward, will the ceasefire embolden President Trumpto ramp up his protectionist urges elsewhere, in particular,with a protracted trade fight with Europe? The digital turnover taxes on US tech giants imposed by France and other EU members may well stoke up President Trump’s instincts. We also have ‘phase two’ of the deal to look forward to over the next few months, which will go on after Secretary Mnuchin stated on Tuesday that tariffs on Chinese goods coming into the US are likely to stay in place until after the US presidential election.

Elsewhere, poor UK macro data has further cemented market pricing of a January rate cut at the Bank of England meeting on January 30. The economy shrank 0.3% in November ahead of the general election, against a median forecast for flat growth, while inflation hit three-year lows yesterday. The markets haven’t blinked with the January meeting rate cut odds rising to about two-thirds, from only 5% last Wednesday. 

Amongst all this dovish chatter, we note that the 1.3% inflation print was only marginally lower than the MPC’s 1.4% forecast. It was also driven by moves in airfares and hotel prices – historically volatile sectors which may not be that strong a basis for new stimulus.

The main longer-term risk to the UK economy remains the progress in trade negotiations with the EU which will kick off in earnest in early February. Before that, next week’s January PMI will be key in potentially giving further ammunition to the doves. Carney hinted last week that another agent’s report might be needed before confirming his views. This potentially leaves new Governor Andrew Bailey to move rates later in the first half of the year at the May meeting, which will have new quarterly forecasts.