• A ceasefire in the trade war is as good as it gets at the G20. It is good news for financial markets and the global economy and it paves the way for a real deal in 2019, which removes all tariffs imposed and leads to a further opening of the Chinese market.
  • Trump’s need for a deal with China and a strong US economy when he goes into the 2020 election campaign increases the chance of an end to the trade war in 2019.
  • While we should expect bumps in the road, we continue to look for a deal next year and odds are rising it could come as early as the end of Q1.
  • However, the long-term rivalry between US and China is here to stay. It is set to change from trade war to tech war and rivalry on the global scene.

The facts and initial responses

A statement released by the White House after the dinner called the meeting ‘highly successful’ and listed the following key features of the agreement.

  • A 90-day ceasefire with no increases in tariffs or new tariffs imposed. If no agreement is reached after this period, the 10% tariff rate on USD200bn worth of Chinese goods will be raised to 25%.
  • China agreeing to buy a not yet specified, but very significant, amount of US goods within agriculture, energy and industry products.
  • Immediately beginning negotiations on ‘structural changes with respect to forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusion and cyber theft, services and agriculture’.

In addition, Xi stated he was open to approving the previously unapproved deal between the US mobile technology company Qualcomm and Dutch NXP (a semiconductor company). Xi also agreed to designate Fentanyl as a Controlled Substance, meaning that people selling Fentanyl to the US will be subject to China’s maximum penalty under the law.

Trump was quoted saying: ‘This was an amazing and productive meeting with unlimited possibilities for both the United States and China’.

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China’s foreign minister Wang Yi, who sat next to Xi Jinping during the dinner, said afterwards that ‘the discussions on economic and trade issues were very positive and constructive’ and added that ‘the two sides agreed to mutually open up their markets and as China advances a new round of reforms, the United States’ legitimate concerns can be progressively resolved’. The word ‘legitimate’ is noteworthy here as it shows China acknowledges it needs to do more to open up further. Here’s a China Daily overview of the agreement.

Outlook: deal likely in 2019 before Trump enters 2020 campaign

The agreement is as good as it gets at this stage and shows in our view that after Trump stating for a long time that it was not time to talk, he now wants to go into serious negotiations. After he left the negotiating table in May, it was clear he wanted to put pressure on China first by raising tariffs before he was ready to talk. Judging from his initiative to restart the trade negotiations, he believes he has added as much pressure as he can and that further tariffs could end up hurting his own hand in the trade talks. As we argued in the US-China Trade – Five reasons why we still see a 60% chance of ceasefire, 29 November 2018, a further escalation could hurt the US economy and stock markets further.

The next three months we are set to see intense negotiations between the two sides and we expect it to be a bumpy ride towards a deal. Most likely China will send a big team of officials to Washington as early as mid-December. They will be led by China’s economic tsar Liu He and the US trade team will probably be led by US Treasury Secretary Stephen Mnuchin but with US Trade Representative and trade hawk Robert Lighthizer playing a central role as well. Trump and Xi also agreed to meet again soon. A meeting will most likely take place during Q1 next year.

We expect an end to the US-China trade war next year to remove a significant negative tail risk for the global economy and financial markets. The probability of moving into ‘phase three’ (as Trump has called it) with a further escalation has now been reduced and should thus already now be positive for market sentiment. A resolve of the trade conflict is set to help the global economy to stay robust and will not least underpin a recovery in China during the year. It is thus set to remove a significant drag from the biggest contributor to global growth, as China drives one-third of the expansion in the global economy.

Trump to face criticism as ‘Made in China 2025’ is not addressed

Trump is likely to face criticism from some fellow Republicans and from Democrats that a deal with China is not tackling the industrial policy ‘Made in China 2025’ with big investments in technology. It is not mentioned at all in the statement and it is one of China’s ‘red lines’ in the trade war. China simply sees it as necessary to continue climbing the development ladder and not get stuck in the ‘middle income trap’.

Lighthizer and ultra-hawk Peter Navarro might be unhappy about the agreement as well, as they seem to be in favour of going all the way on tariffs. However, Trump’s pain threshold is probably not high enough when it comes to the economic cost domestically as he is eyeing the 2020 presidential election campaign. In our view, he aims to campaign on a China trade deal and a strong economy on top of issues such as immigration and crime. He thus needs a trade deal to be done in 2019.

Despite some criticism, we believe Trump will be able to sell it as a big win to his voters. He will point to (a) he is the first president that has really stood up to China and (b) he has secured a big increase in purchases of farm products and energy and a further opening of the Chinese market.

Long term rivalry to continue despite trade deal

While we look for a deal, possibly as early as end-Q1, we still believe we are only at the beginning of a long-term US-China rivalry, as China is rising to surpass the US economy over the next 10-15 years and by 2050 could be double the size of the US economy. However, it will move from a trade war to a tech war and increasingly be focusing on US protection of technology and big restrictions on technology exports to China. We have already seen that this year. The rivalry will also be intense on the global scene, not least in Asia with more ‘Freedom of Navigation’ cruises in the South China Sea and the Taiwan Strait.

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