Markets have been reacting quite positively to the announcement during the Buenos Aires G-20 that the US had agreed to freeze planned new tariff actions against China. I want to give you some of my thoughts on what could happen next in that relationship and what all of this means for the global economy. So, let me start with what was actually agreed this weekend.
The Escalation Freeze
Put simply, what’s happened is the US has put a temporary 90-day freeze on the trade war escalation that it had planned for the beginning of 2019. And in return, China has made a few concessions. You can see the outline here in the White House statement issued on Saturday. Below are the key points:
- Tariffs on $200 billion of Chinese goods won’t be raised on Jan 1st. But those tariffs will be raised to 25% if China and the US cannot reach a deal in the next 90 days.
- The Chinese said that both leaders asked their negotiating teams to speed up talks, to work toward a deal which would scrap all tariffs.
- As a quid pro quo for the freeze, China has agreed to purchase “very substantial” amounts of US farm, energy, industrial and other products. They will also immediately start buying American agricultural products like soybeans again.
- Xi will also reconsider the Qualcomm-NXP deal.
- And finally, China will classify Fentanyl, the drug causing so much havoc in the opioid addiction crisis, as a controlled substance.
- Additionally, the two countries will work toward a nuclear-weapon free Korean peninsula.
How to judge the trade war freeze
A couple of things here: this is a freeze. So none of this is permanent. I reckon Trump saw a freeze as a quick win. Trump sees stock market gains as affirmation of his efficacy as US President. And so, he has become concerned about the blame for the stock market’s fall that many have placed on trade tensions. He has tried to fault the Fed. But still, having ninety days affords Trump an opportunity to see whether the economy decelerates from here. And that will guide him on how aggressive he will be regarding protectionist moves if a deal isn’t reached.
In addition, in some senses, this really isn’t as big a deal economically as it seems. China’s current tariff on cars is 40%, only because of Trump’s tariff moves. China had a 25% tariff on foreign cars. But, in April, in a speech at the Boao forum, XI had announced a plan to reduce to 15%, as a sign of conciliation. But, after Trump hit China with more tariffs, Xi bumped US car tariffs up to 40%. So, going forward, the real question is whether China would go lower than 15%.
Finally, your base case has to be no deal when this 90-day period ends on March 1st. There are huge differences between the US and China on difficult issues like Chinese industrial policy and on intellectual property. After an initial pop, many Chinese, US and Asian companies will continue to face uncertainty, especially since the quid pro quo terms that China has agreed to aren’t very specific. According to the US, China pledged to buy “a not yet agreed upon, but very substantial, amount of agricultural, energy, industrial, and other product”. But, China did not mention any purchases in its press release.
Oh, and remember by March 1st, the 2020 election timetable will have started. People will have started to announce their candidacy by then. So, that’s going to weigh on Trump as he decides how to act.
The economic outlook in China and Japan
The starting economic conditions for the emerging markets and Asia are not very good. A slew of Asian PMI data ht the wires last night as I was preparing for bed. And the numbers were poor. And let’s remember that supply chains for Chinese manufacturing stretch right across Asia. So trade tensions are having a region-wide impact.
I would highlight four countries’ PMIs as a broad cross-section of economic activity here. I tweeted some of this last night.
China, which has no growth in manufacturing:
The Caixin China manufacturing purchasing managers’ index edged up to 50.2 in November from 50.1 in October, moving slightly higher above the 50-point level separating expansion from contraction.
Production remained unchanged from October, the survey found, but total new orders picked up for a second straight month. However, demand from abroad flagged as a sub-index for export orders dropped further into contraction.
The results of the Caixin survey, which focuses on smaller and private companies, follows the official PMI reading of 50 from the National Bureau of Statistics released last week.
The no-growth reading for the official headline figure, which tracks larger and mostly state-run manufacturers, marked the first failure to expand since July 2016 and came as a sub-index for new orders dropped closer to the 50-point line and contraction in export orders continued roughly apace from the previous month.
Japan, where numbers are the weakest in over a year:
November survey data revealed that Japan’s manufacturing sector continued to expand, albeit to the weakest extent since August 2017. Weighing on the overall rate of improvement were slower rises in production and new orders. Export orders also increased at a weaker rate amid reports of softer demand from China and Europe. Meanwhile, firms were less upbeat towards future output than in October, with confidence falling to a two-year low. Nonetheless, additional staff were hired, while input buying grew at an accelerated pace.
The headline Nikkei Japan Manufacturing Purchasing Managers’ Index (PMI) – a composite single – figure indicator of manufacturing performance – fell from 52.9 in October to 52.2 in November, therefore pointing to a slower rate of improvement in business conditions. The latest reading for the headline index was the lowest since August 2017.
Elsewhere in Asia
Indonesia, on the verge of contraction:
Growth momentum in Indonesia’s manufacturing sector slowed further midway through the fourth quarter amid soft demand conditions. While output continued to increase, overall new orders were largely stagnant. There was evidence that higher prices weighed on client demand.
Supply chains remained stretched as weather-related disruptions and material shortages hampered distribution efforts. Weak demand saw firms holding back on buying activity. Employment also grew at a slower pace. Inflationary pressures meanwhile remained strong. That said, business confidence continued to be positive.
The headline seasonally adjusted Nikkei Indonesia Manufacturing Purchasing Managers’ Index dipped to 50.4 in November from 50.5 in October, marking another marginal improvement in the health of the sector. The latest reading was the lowest for five months. The headline PMI provides a snapshot of the manufacturing performance in the country and derives from questions on output, new orders, employment, inventories and delivery times.
And Thailand, where November PMI data is the backdrop for the weakest quarterly performance in the manufacturing sector in two years:
Thailand’s manufacturing conditions deteriorated further midway through the fourth quarter amid signs of softer client demand. Output strengthened, but total new sales fell further despite a rise in overseas orders. Employment remained soft while supply chains were capable of handling firms’ input demand…
The seasonally adjusted Nikkei Thailand Manufacturing Purchasing Managers’ Index rose from 48.9 in October to 49.8 in November, indicating a marginal deterioration in the health of the sector. The headline PMI provides a snapshot of the manufacturing performance in the country and derives from questions on output, new orders, employment, inventories and delivery times.
The US Federal Reserve
In the US, I honestly believe the holiday sales numbers are going to turn out ok. So, in January, we are going to get a slew of numbers that will confirm that the US expansion remains on track from employment and wages to consumption, services, production, new orders, and business confidence. That’s my prediction.
What that means is that the Fed will have raised rates once later this month, followed by relatively bullish incoming data in January. The next hike is scheduled for March. And all during that time frame there will be a freeze on new tariffs on China. And so that means the data would need to drop dramatically in February or the end of the freeze on March 1st would have to put the Fed off enough to change guidance in the March meeting.
So, my base case is for the Fed to continue to signal four more hikes through the end of 2019, including two that they execute later this month and then in March. Between March and June, the Fed will then have time to reassess and push back its timetable, depending on the incoming data. Some of this will be informed by what’s happening in the credit markets.
So, overall, this freeze in the US-China trade war is bullish, but not dramatically so. At the margin, it might actually help growth in Asia, taking away one cautionary note for the Fed. And since I expect the US economy to continue to hum along at a level that means no guidance change, this China news is modestly bearish for interest rates in the US.
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