May 10, 2019
“If you like to gamble, I tell you I’m your man. You win some, lose some, all the same to me.”
Lyrics from “Ace of Spades” by Motorhead
The above quote does not portray a cavalier attitude toward trade, but it exemplifies the ultimate success of any trade deal rests with top leadership: President Trump and President Xi.
The roles of U.S. and China trade delegations have been like a realtor in purchasing a home. Each delegation has been an agent representing the terms of each respective buyer (Trump and Xi) subject to inspection before the final terms of an agreement. When China tried changing the terms, the U.S. balked.
U.S. tariffs of 10% on $200 billion Chinese goods (in effect since September 2018) have increased to 25% effective today following the recent escalation in trade tensions. A small “tariff deferral window” was submitted by U.S. Trade representatives in the formal language of their May 9 memo modification. It offers a transit provision that applies tariffs only to goods shipped or “in transit” after the May 10 deadline. In other words, if goods are already in U.S. circulation, the 25% tariffs don’t apply. The deferral window buys time for negotiators and their leaders to finalize a deal hopefully ending the impasse soon.
A China Response:
There will likely be two primary responses from Chinese leadership.
- Tariff Retaliation:
- Look for a possible reinstatement of auto tariffs suspended on Dec. 14.
- Scaling back on previously agreed upon purchases of U.S. agricultural products such as soybeans is a possibility.
- We will know more by the end of the weekend.
- Chinese Stimulus:
- To counteract the negative impact from prolonged disputes, China will look to inject additional fiscal or monetary stimulus such as lowering interest rates, cutting taxes, easing regulations or infrastructure spending.
- Economic stimulus can provide a safety net for their ongoing recovery making it less susceptible to trade induced economic deterioration.
Moving Through the Impasse:
The next steps toward a deal are already underway, but impasse does not mean impossible. We ultimately think a deal gets done with Trump and Xi expressing public enthusiasm over its conclusion but private consternation over its content. Both leaders underestimated the resolve of one another because each knows what is at stake. Those stakes are high and global ripple effects are wide reaching, but keeping perspective while negotiations continue is critical. While the contentious turn of events this week doesn’t match the positive expectations from just two weeks ago, it would be hard to frame this impasse as surprising.
Several challenging themes run through this negotiation process each with its own story regarding outcomes and impact. The bottom line is any combination of these issues contributes to elevated economic and or geopolitical uncertainty.
- USMCA Trade Deal: The replacement of NAFTA still has yet to be ratified by U.S. Congress. The trade dispute with China complicates this.
- Any trade deal between the U.S. and China could also have negative supply chain or “goods substitutes” implications potentially impacting an already strained European comeback.
- European economies are more sensitive than the U.S. to China’s growth so any threat to Chinese growth is a greater threat to Europe.
- South China Sea/Taiwan Strait: China has challenged the boundaries of these international waters as the U.S. Navy has tested China’s resolve several times in 2019 by sailing through the contested Taiwan Strait. This issue in not mutually exclusive to the ongoing trade dispute.
- Iran/Oil: China has been less than compliant with U.S. demands for sanctions on Iranian oil exports. This is not only a sticking point in trade negotiations but has implications for oil suppliers, demand and pricing.
- Fed Policy: Some have argued a failed trade policy could or should prompt the Fed to offer yet more financial sustenance through a rate cut. This is unlikely and would be ill advised.
- Business Confidence: Since early 2018 we have said the biggest risk to the trade dispute was depressed business sentiment and muted Capex. Business sentiment remains contractionary and Capex has been underwhelming. A second half 2019 pickup is critical for continued economic expansion in the U.S.
- Global Markets: Month-to-date returns for global equity markets have moved in lock step for the U.S., Europe and Asia in -3% to -5% range as of this morning. The trade dispute is the primary cause for the downturn, but a resolution could be the primary cure.
We’ve now had over a year of escalated trade threats and tariff implementations yet the U.S. enjoys the lowest unemployment rates in 50 years, rising productivity growth, rising income growth, low interest rates, low inflation and recent signs of resurging growth. Today’s tariff increase does feel different than what we’ve had the last year as a crescendo of high expectations have disappointed. Though the clock struck 12 last night with the tariff increase and stakes remain high, negotiations continue and we think ultimately result in a diluted deal. Markets wax and wane through periods of uncertainty, and today uncertainty remains elevated. Markets often emerge from periods of elevated uncertainty with respectable returns.
Recent economic evidence continues to suggest increasing signs of global economic stabilization and growth especially in the U.S. It’s important to prioritize economic data within the context of rising geopolitical risks (not the other way around). Recession indicators remain benign, but we can’t deny the rising risks that a failed trade deal could have on global economies. We remain slightly overweight to equities in our portfolios with our eye on resurging second half growth in 2019. If future evidence dictates a change in our positioning, we will communicate that as well. As always, thank you and please don’t hesitate to reach out to your BB&T Wealth Advisor or Portfolio Manager with any questions.
Jeff Terrell, CFA
Chief Wealth Market Strategist
Sources: Strategas Research Partners, Evercore ISI, FactSet, Goldman Sachs Global Investment Research, Morningstar, BCA Research, Standard & Poors
The information set forth herein was obtained from sources, which we believe reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Diversifying investments does not ensure against market loss and asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Past performance does not guarantee future results.