The US China Trade war has had a huge lingering impact on markets over the past 18 months or so. With “Phase 1” of a deal now complete late last week, what lies ahead?
The answer to this question will begin to drive a lot of asset classes globally – as we head into a week full of data (September US unemployment data being the most important release this Thursday , October 17 2019 followed by Chinese trade data for September)-
Also, while the US dollar being strong is good for Asian exporters, it also spells doom for the mountains of debt piled up by corporates and governments globally- the trajectory of the US growth therefore will determine how the next 3 to 5 years pan out and we are possibly at the cusp of getting visibility on this.
Whats Up Uncle Sam!
Almost 18 months after the US-China trade fight began, the two sides completed ‘phase one’ of a bigger trade deal, requiring Chinese purchases of US agricultural goods, some intellectual-property and currency measures and access for US financial services in return for US refraining from the planned October tariff hike on USD250bn of Chinese goods.
The two sides will now have to write down the trade deal over the next three to five weeks.
Chinese media, while noting progress, warned not to be ‘overly optimistic’ about the prospects for future negotiations.
The completion of ‘phase one’ of the trade deal could likely boost market confidence further near-term as it removes some uncertainty, In FX markets, the temporary boost in market confidence provides an opportunity to position for further broad dollar strength.
Even the much talked about recession predictor, the inverted yield, “uninverted” for the first time since mid-July as positive “hard” US economic data continued to undermine the weaker messages from “soft” data surveys.
For the medium term however, there is some degree of uncertainty still left. Note that the deal just avoids next week’s tariff hikes but does not reduce any of the tariffs put in place over the last 18 months, let alone cancel the US tariff hikes planned for December. For the time being the existing tariffs between the US and China on around $1 trillion worth of goods are still very much in force.
Of course, it may still to some extent help the emerging economic stabilisation that we are seeing in China, which will also at some stage benefit the rest of the global economy.
The signals from China have been that 80% of US demands have been met, but the last 20% is an infringement of Chinese sovereignty and would compromise China’s development model. China also wants tariffs to be rolled back in full as part of a big trade deal. Trump, on the other hand, has said he would only take a deal if it were a ‘big deal’. Otherwise, he is happy without one. This risk therefore remains a large one.
Adding to those trade concerns, the Trump administration won approval previous week to slap import tariffs on $7.5 billion worth of European goods, threatening a further escalation of the trade war instigated by the White House 15 months ago.
However, there is still a possibility that he would give in next year when the November presidential election moves closer. His hand is weakening currently as the US economy is slowing down and manufacturing jobs are going down again.
The impeachment process, however, is a new big unknown factor in relation to the prospect of a deal. If Trump ends up impeached, it is highly uncertain how it would affect the White House stance.
US Growth Data
Last Friday’s US jobs report was mixed at best, with its unemployment rate dropping a notch to near 50-year lows of 3.5 per cent but where wage growth was absent, and with manufacturing, retail and utilities all under pressure.
One gauge of U.S. factory activity suggested that manufacturing had dipped to its lowest level in 128 months. Corporate profits are stumbling too. The S&P 500 as a whole reported a fall in earnings in both the first and second quarters of 2019.
The Fed now expects growth this year, as measured in U.S. gross domestic product (GDP), to come in at 2.2%, well below the Trump administration’s long-held 3% target.
What the Future May Hold?
The results of a survey by the US thinktank, NBAE, conducted the week of Sept. 9-16, come as many analysts see warning signs in the latest U.S. economic indicators, including a plunge in manufacturing activity to more than a 10-year low in September and a sharp slowdown in service-industry growth to levels last seen in 2016. Those reports last week heightened fears the economy may be flirting with a recession.
80% of the 54 NABE economists surveyed said the economy is at risk of slowing further, up from the 60% who said so in June. In their latest survey, NABE panelists said they expect real gross domestic product will continue to expand at an average rate of 2.3% this year but will slow to 1.8% in 2020.
A small majority of the Washington-based association of business economists also expects that the Federal Reserve will remain on hold through 2019, while 40% of the group saying they expect at least one more rate cut this year.
The panel also expects industrial production to slow sharply from 4% in 2018 to just 0.9% in 2019. That represents a big downward revision from the previous estimate of 2.4% in the June survey. And the group expects corporate profits to grow just 1.7% this year, down sharply from the 4.6% forecast in June.
They also see the trade gap widening significantly — from $920 billion in 2018 to $981 billion in 2019 and to $1.022 trillion in 2020.
Much of that gap, the panel said, will come from slower export growth — down from 3% in 2018 to 0.1% in 2019. That’s a big drop from their June estimate for 2019 of 2.5% export growth. While the group expects the economy to maintain forward momentum for another 12 months, the odds of a recession are expected to rise next year.
Panelists put the odds of an outright recession this year at just 7%, with a 24% seeing a recession starting by the middle of 2020. They put the odds of a recession starting by mid-2021 at 69%.
The above indicates therefore that we are miles away from a recession unless something goes terribly wrong and the ability of the Asian tigers to benefit from this slower but large absolute growth may just be the trigger for economic revival.
US Dollar – Strong with Increased Risks
The findings in a section of the IMF’s Global Financial Stability Report show that the “funding gap” of non-US banks–the difference between assets and debt held in US dollars — has surged to $1.4 trillion, 13 per cent of assets!
This could cause markets to seize up if there a repeat of the situation at the start of the global financial crisis, when institutions hoarded dollars and were reluctant to lend which meant the cost of any the scarce funds available soared, the IMF warned.
China has also fueled its economy by loading up on debt and the numbers have gotten breathtakingly large. The Washington-based Institute of International Finance (IIF) has estimated that in the first quarter of 2019, the total amount of corporate, household and government debt in China hit 303% of GDP!
The report said Beijing’s attempt to rein in non-financial corporate debt had been rather defeated by borrowing in other sectors which had brought China’s total debt pile to more than $40 trillion.
China policy levers are hampered by the risk that choking off further debt could accelerate the slowing of economic growth that is already underway.
Added to this is the issues at Hong Kong. This region acts as one gateway in and out of the Chinese economy with banks based there funneling capital from international investors. Continued civil unrest could, therefore, affect economies all around the world as trade is disrupted and investments seize up.
Should China decide it has to tighten its grip further then the future of the “one country, it might drag the United States into the fight as it has legally promised to treat Hong Kong separately from mainland China for matters concerning trade and economic policy.
What you could do?
Given the risks pointed out by IMF, which are by the way double of 2008 in terms of potential magnitude, the next 2-5 years may be extremely volatile as the world adjusts to a US recession and possibly buoyant emerging economies. The adjustment, maybe in a year from now, could be painful whenever it does occur.
One would believe that Dollar and Gold would therefore remain buoyant.
For clients and treasuries where FX net exposure to the US dollar is high, current levels should be used to lock in hedges for the remainder of the year especially as upside risks to relative Indian inflation – especially upside in Indian agriculture and downside in US retail- have increased. USD vs INR may remain strong even in a slowdown scenario. Increased weakness in IIP numbers doesn’t also bode well for the INR structurally.
We have also been recommending gold since early this year and the likelihood of upward buoyancy is increasing for the medium term even though the China deal may cause jitters to Gold in the short term. Gold could have possibly resumed a structural upward trajectory and therefore at least 5% of client portfolios should be invested here- at least as SIPs into Gold ETFs via any of our offices nationally or via www.plclients.com>Products>SIS.
It does also look like increased USD strength , post the immediate negative reaction maybe next week because of the deal, may cause yields to strengthen in India – one would therefore think that longer term debt , which has had a field day – returning in excess of 20% – because of falling yields, should be switched to shorter term / dynamic mutual funds to benefit from short term yields rising. Of course, one could do this in a phased manner over the next few weeks as IIP softness may keep a lid on this.
Of course there are international mutual funds one should and could look at – Read more at https://www.plindia.com/blog/international-mutual-funds-have-you-diversified/
One thing is for certain though – When the US begins to sneeze harder, prepare to keep your cold medicines handy!