The direction of US-China trade talks has ebbed and flowed, but we see sufficient positive momentum to support our base case that a phase 1 trade deal would be ratified in the months ahead.
With the cancellation of the APEC summit in mid-November, one potential deadline to watch is 15 December, which is when the next set of US tariffs are scheduled.
We expect the phase 1 trade deal to feature substantial agricultural purchases by China, the suspension of the 15 December tariffs, and possibly the further opening-up of China’s financial markets. More substantive and difficult issues, such as industry policy reform, technology transfers, intellectual property rights and others, would be pushed back to phase 2 or later.
Despite fundamental disagreements over many major issues, the interests of both the US and China are currently aligned in terms of the limited scope of the phase 1 deal. A successful phase 1 deal will be a positive factor for sentiment and financial conditions, which further adds to the likelihood of our baseline scenario of growth stabilization in 2020.
Already, we detect some hints of this from incoming economic data. The US ISM manufacturing PMI has rebounded from its low level in September, echoing the trend in the Eurozone Markit manufacturing PMI. Latest industrial production figures from Japan and Korea were also firmer than expected, which resonates with similar messages from other Asian economies.
The ongoing negative spill-over from the weak manufacturing sector to the still relatively healthy service sector and consumer spending is worrying, but if manufacturing stabilizes ahead, this drag would not be severe enough to pull the overall economy into a recession.
Latest reports also suggest that the slowdown in hiring in the US labor market is less than feared. Initial jobless claims and continuing claims last week came in within expectations, pointing to a labor market that is losing some strength but not collapsing.
Overall, the trimming of global tail-risks related to US-China trade, Brexit and Italy, together with incoming economic data so far corroborating our base case that we will avoid a recession in 2020, translates to a firmer fundamental picture for markets.
The potential for some near-term market volatility is significant, considering 1) the capricious nature of US-China talks, 2) anxieties related to the 2020 US Presidential elections, particularly as Elizabeth Warren emerges as a potential Democrat nominee, and 3) the Fed on pause even as the negative effects of previous tariffs continue to work through the economy.
But this is offset by abundant liquidity and healthy financial conditions, as all three major central banks – the Federal Reserve, European Central Bank and Bank of Japan – are expanding their balance sheets and purchasing a combined total of more than USD120b of assets per month.
The Fed’s commitment to keep rates at current or lower levels for what is likely until 2021 at the earliest also comprise a tailwind for markets. If economic conditions stabilize in 2020 as per our baseline expectations, risk assets will benefit from a prolonged period of low rates until such time when inflation pressures clearly exceed the Fed’s symmetric 2.0% target level.Disclaimer applicable to recommendation
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