A guide to the G20 meeting, and why a trade deal is not on the cards
Many G20 meetings come and go, most analysts don’t even bother to read the communique that is released at the end of each meeting, however, this year it’s different. Every analyst and trader will be watching developments closely in Japan this weekend, as expectations rise that the US and China will use this meeting to agree a long-awaited trade deal.
However, after months of rhetoric from both sides, trade tariffs and deals nearly signed and then aborted at the last minute, has the market blown this G20 meeting out of all proportion? For those who trade major market themes, it’s important to plan for realistic outcomes from this meeting. Below we look at some potential scenarios and give our view on the most likely outcome.
1, Xi and Trump talk it out
As we lead up to this meeting President Trump has said that it is “possible” that the US could reach a trade deal with China during this meeting, however, he also said that additional tariffs remain on the table if not. This is a more muted message compared to what the US Treasury Secretary, Steven Mnuchin, said earlier on Wednesday that a deal between the US and China was “90% complete”. At this stage of the ongoing trade saga, who knows what is coming up. US stock markets have managed to hit record highs while the US and China have attacked each other with trade tariffs, thus, the stock market’s bar for success from this G20 meeting could be quite low. We do not expect an all-singing, all-dancing trade deal between China and the US this weekend, instead we believe that a successful outcome would be for Presidents’ Xi and Trump to sit down, have a conversation of a decent length with positive comments from both sides afterwards. If this positive tone is reflected in the communique, which is usually released at the end of G20 meeting, then the market may be satisfied, and this could spur the next leg of the global stock market rally.
2, A breakdown in talks
This has happened before, and with both sides willing to play hardball when it comes to trade, we cannot rule out the prospect that the talks could breakdown leading to a fresh round of tariffs. As mentioned above, this has been threatened by President Trump ahead of this meeting.
A “no deal” outcome from this meeting, combined with an escalation of the war of words between China and the US, is likely to spook risk sentiment at the start of next week, and stocks and other risky assets could fall sharply. This scenario would be good news for gold bugs, as gold and other safe havens such as the Japanese yen and the Swiss franc, would most likely rally on the back of an adverse outcome from this meeting.
We should point out that at this stage, we don’t think that this is a likely scenario, and we expect Trump and Xi to engage in fruitful conversation in Japan. However, if the talks break down and further tariffs are implemented next week then the silver lining could be a Fed rate cut next month. As it stands, the market is fully expecting one 25 basis point rate cut when the Federal reserve meets next month, however, there is currently a 26% chance that the Fed will cut rates by 50 basis points. We believe that expectations for a larger rate cut would surge if Trump and Xi fail to resolve their differences this weekend. This would have big ramifications for financial markets: bond yields would most likely fall, particularly at the short end of the curve, which could weigh on the dollar in the short term. In this scenario, it is worth watching EUR/USD closely. The euro has picked up strongly vs. the USD in the past week, rising from 1.1180 to a peak just above 1.14 earlier this week. If the dollar falls on the back of this meeting, then the euro could regain the 1.14 highs and EUR/USD may re-test the January highs around 1.1550. USD/JPY could also fall sharply; it has already fallen below the psychologically important 108.00 level, although it has tried to claw back gains, momentum remains to the downside, and technical indicators suggest that sentiment towards this pair remains negative. Thus, it wouldn’t take much of an escalation in tension between the US and China to push USD/JPY back towards 105.00, the low from March 2018, and an important support zone.
3, Why we will get a deal in the end…
Although we think that this meeting may not deliver a long-awaited trade deal, we strongly believe that reaching a trade deal is in both the US and China’s interests, and if the deal isn’t reached this weekend then it will come in the next few months. US economic data has taken a turn for the worse, today’s offering came in the form of a 1.3% drop in durable goods orders for May. The Citi economic surprise index for the US is now at its lowest level since 2017. This is in contrast to the S&P 500 which remains close to record highs.
Trade data has been relatively strong of late, US exports rose 3% in May. Thus, if the US can score a trade deal with China and boost trade, this could have a positive impact on overall economic growth just as Trump attempts to win a second term in the White House. Likewise, as China’s economic slowdown deepens, Beijing could also benefit from a deal with the US. External pressure to find a deal is also building, Citi’s global economic surprise index has experienced its longest ever spell in negative territory. Added to this the Vix index, a measure of volatility on Wall Street, has nudged higher since May. With Trump up for re-election in 2020, we believe that all of these factors will pressure him into signing a trade deal with China, if not this weekend, then in the coming months. If this is signalled at this G20 meeting, then a rate cut from the Fed next month, combined with a whiskey chaser trade deal could be the cocktail needed to push the S&P 500 into fresh record territory and above 3,000.