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AXA IM's Aidan Yao: US-China's trade talks back on track after G20

By AAN team | 03 Jul 2019

Aidan Yao, Senior Emerging Asia Economist at AXA Investment Managers (AXA IM) discusses the outcome and implications of US-China trade talk at G20.

While the market was closely watching the US-China meeting at G20, it ended with little surprise. President Xi and Trump agreed, as expected, to get trade talks back on track after almost two months of hiatus that had led to escalated confrontations. To show some good faith, the US has agreed to halt the pending tariff hikes on some USD300bn Chinese products “for the time being”, while China has reportedly agreed to start purchasing US farm goods “effectively immediately”.

The only unexpected outcome was related to Huawei, with the company allowed to resume business transactions with US firms. However, Trump clarified that this is only a temporary solution to the situation; Huawei, for the time being remains on the Commerce Department’s “entity list” and the issue will be saved until the very end of the negotiations.

Overall, the outcome of the G20 meeting was broadly inline with our expectations: a successful aversion of a further trade escalation has brought the two sides essentially back to a pre-May 6^thsituation. Beijing and Washington now get another shot at negotiating a trade deal, even though there wasn’t much from the G20 suggesting any breakthroughs were made in resolving the remaining differences.

This means that the level of uncertainty with respect to future trade talks will remain elevated. We will be watching the following three issues to assess the prospect of a resolution:

First, the focus of the trade talks matters. As discussed previously, the pure trade issues – relating to closing the bilateral deficit – are easy to resolve. What has made a deal so hard to strike is that the US has lumped the more contentious issues, relating to technology and China’s industrial policies, together with trade and made even the trade problem difficult to address. But if the new round of negotiations makes a better segregation of the issues and stays focused on closing the trade gap, the odds of a deal can be quite high in the coming months.

The second is politics, which can dictate the direction of trade talks. As the US presidential race heats up, containing the “China threat” will likely be one of the focal points in the campaign. To the extent that “China bashing” further elevates anti-China sentiment, it will create a difficult environment for Trump to agree to a deal without being blamed for letting Beijing off the hock too easily.

At the same time though, if the US economy continues to slide, driven partly by the tariff spat, Trump may feel the political pressure to save the economy and his re-election by getting a deal done quickly. Hence, the political dynamics could work both ways for or against a deal.

Finally, the financial market movements can be an important consideration. A sharp rebound of global markets, akin to what was observed post the G20 last year, can remove the urgency for Trump and Xi to reach a compromised deal that both sides consider suboptimal. Hence, a positive market reaction to the Osaka meeting could, in a perverse way, hold back deal-making in the coming months.

These persistent uncertainties surrounding trade negotiations will cloud the economic outlook. Even without additional tariffs, the existing ones, particularly those levied last month, will continue to weigh on the US and Chinese economies. The latest Purchasing Managers' Index (PMI) for China suggest continued malaise in the manufacturing sector, which calls for additional policy supports to counter growth pressure. We think a combination of fiscal and monetary stimuli will be rolled out in the coming months, enough to keep growth above 6% for 2019.

For the US, the avoidance of a full-blown trade war will substantially reduce the odds of a recession. However, the weakness of global trade has shown signs of spilling over to the US manufacturing sector and financial conditions. We forecast growth of 2.4% this year, but expect it to slow to 1.6% in 2020, softer than the consensus outlook.

On the policy front, will the avoidance of the worst-case scenario lead the Federal Reserve, People’s Bank of China and other central banks to take their feet off the gas pedal? Given the importance of anticipated policy easing in driving the recent market rally, it is not clear how a change to these expectations, in conjunction with the trade news, could drive the market beyond the positive knee-jerk reaction. For the time being, we expect two interest rate cuts from the Fed this year, starting from September, and two reserve requirement ratio (RRR) reductions by the People’s Bank of China in H2. However, if the trade situation takes another turn for the worst (which cannot be ruled out) and economic data deteriorates further, policy support could be greater and delivered earlier.