U.S.-China trade agreement, U.K. election, Fed easing: stronger base case, but risks remain
A trio of market-relevant news hit the headlines within the space of 24 hours on Thursday: a trade agreement between Washington and Beijing, a decisive U.K. vote, and more monetary easing from the U.S. central bank.
A “phase 1” trade deal between the United States and China was reached last week, which means the much talked-about tariff hike scheduled for December 15 will no longer come into place. Meanwhile, the Conservative Party in the United Kingdom has won a healthy majority in a closely watched election, thereby removing market uncertainty regarding Brexit, at least for now. Crucially, the U.S. Federal Reserve (Fed) announced that it’ll add US$500 billion to its balance sheet by year end¹—where markets are concerned, what’s not to like?
The global economy is approaching an important inflection point after which we’ll see economic growth/stabilization taking place first in Europe, followed by the United States, and then China and the broader Asian region.
The removal of these tail risks certainly strengthens our conviction in our cautiously optimistic base-case scenario: The global economy is approaching an important inflection point after which we’ll see economic growth/stabilization taking place first in Europe, followed by the United States, and then China and the broader Asian region. These developments are supportive of our belief that it could be time to bring a little risk back to the table, particularly as the Fed and other global central banks are likely to maintain their extraordinarily accommodative stance and balance sheet expansion initiatives for a while. These exercises should keep bond yields stable and low.
However, while the threat of fresh tariffs and yet another inconclusive election in the United Kingdom had weighed on the outlook for 2020, we must note that they were by no means the biggest risks to our expectations for an economic rebound next year. While undoubtedly positive, Thursday’s news developments do little to reduce the fundamental risks to our outlook, namely, a double dose of economic weakness in China, a weaker U.S. consumer, and the structural ramifications of trade tensions and supply chain readjustments.
Notably, where the U.S.-China trade agreement is concerned, we don’t think it’s time to pop the champagne just yet. Here are three reasons why caution might still be warranted:
- This isn’t a finalized deal—even if both sides have agreed to complete discussions “as quickly as possible” and China has said it’ll work to set a date for signing a deal.2 In our view, there remains plenty of scope for things to go awry. In particular, details are particularly fuzzy on whether there will be rollbacks of existing tariffs.
- Details for “Phase 2” negotiations remain unclear, meaning uncertainty could return soon. Notably, the “phase 1” trade deal isn’t likely to define future U.S.-China trade relations.
- From a macroeconomic perspective, the most important issue here isn’t the impact of tariffs but the cost of shifting global supply chains and lost productivity as we embark on the multi-year transition to a new trade paradigm that’ll be ultimately be defined by trade relations between a few key countries.
Within this context, here’s a quick look at how the way we see the world has changed in the past week.
Our key investment views:
1 An inventory rebuild will support a mild to moderate H2 2020 recovery in global growth
Change in conviction: modestly higher
We believe the global manufacturing recession is partly a function of a front-loaded inventory shock that had been exacerbated by the trade shock. In our view, the restocking cycle was always going to proceed with or without a trade deal, but the removal of tariffs that were set to be implemented on December 15 could imply a faster inventory rebuild at the margin.
2 Business confidence has bottomed in Europe and the United States; business investments begin trickling in thereafter
Change in conviction: higher
The deterioration in business confidence globally was also likely to be front-loaded and had begun to turn positive. However, the latest developments probably imply the worst of geopolitical uncertainty is over (i.e., we should now see second derivative improvements on this front). This should contribute to a faster rebound in business confidence globally.
3 Central banks to remain extraordinarily accommodative
Change in conviction: higher
Lower geopolitical risk doesn’t imply less support from the Fed. With an additional US$500 billion of bill-buying adding to the Fed’s balance sheet through to year end, the U.S. central bank will have almost reversed its previous “taper” attempt entirely. We expect this to keep bond yields at the front end contained and becoming slightly steeper. We also continue to expect further Fed interest-rate cuts on the back of persistently weak inflation.
4 Fiscal policy to become increasingly relevant
Change in conviction: higher
We’ll add the United Kingdom to the growing list of countries likely to expand fiscal spending in the year ahead.
1 A double dose of weakness in China
Change in conviction: unchanged
Our concerns about China relate mostly to domestic policies and the local economy—the absence of a massive stimulus program to revive growth, the weak earnings picture in the industrials sector, and diminishing strength in the real estate segment. These relate to the domestic economic cycle, not trade. We believe this is the biggest risk to the global macro story in 2020.
2 U.S. job growth loses momentum; a weaker U.S. consumer
Change in conviction: unchanged
Leading indicators continue to suggest we’re in a late cycle and weaker structural growth in the United States could mean fewer job gains and a less active U.S. consumer.
3 Geopolitical risk events remain elevated; supply chain disruptions continue
Change in conviction: unchanged
We’re no closer to understanding what the long-term U.S.-China trade relations will look like. Similarly, as Washington continues to reassess its trade relations with its partners, trade tensions could easily return to the fore.
1 Bloomberg, as of December 12, 2019. 2 “U.S. and China Reach Initial Trade Deal”, New York Times, December 13, 2019.
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