After two years of unnerving markets, the US and China this week finalised stage one of a new trade agreement.
In line with the announcement made before Christmas, the deal involves the US refraining from increasing tariffs further and will also halve the 15 per cent rate introduced on circa $US120 billion of imports in September 2019 to 7.5 per cent.
In return, China has pledged to increase imports from the US by $US200bn over the next two years (benchmarked against 2017 import levels) across manufacturing, energy, agriculture and services. China has also agreed to provide US firms with greater access to some sectors of its economy and to increase protection around intellectual property.
However, the US’s 25 per cent tariff on $US250bn of Chinese imports will remain in place indefinitely. China’s existing tariffs on US goods will also endure.
In addition, a full resolution to this conflict is reportedly not an option until after the next US Presidential election in November and also depends on China’s willingness to make further changes to economic policy and regulation.
Unsurprisingly, financial markets have reacted mostly positively to the trade developments but aren’t exactly jumping for joy amid scepticism surrounding the details and where the “trade war” ultimately heads next.
But apart from the apparent lack of a full resolution, the reduction in tariffs under stage one of the deal is also conditional on China achieving the $US200bn increase in imports from the US over 2020 and 2021, which as my colleague Rob Rennie has pointed out, will prove very challenging.
As a result, the remaining tariffs will likely remain in place through to at least the end of 2021 and, during this time, a further escalation of tensions will remain a risk.
In a piece this week, Rob points out that markets are already questioning whether China will actually be able to buy the increased exports from the US proposed under the deal, and what this means in terms of potential disruption for the likes of Australia, as an existing significant exporter of thermal energy and agricultural products to Asia.
Clearly, market participants, and nations more broadly, will be closely watching how trade developments between the world’s two largest economies play out.
From the data to hand, most notably key manufacturing indexes, it seems China is adapting to the persistent pressure on trade and growth better than the US, which is struggling. As we continue to emphasise, the prime risk for the US’ economy is if the weakness apparent in manufacturing and business investment across the economy spreads to employment and hence consumption.
Employment and wages were certainly growing at a more modest pace at the end of 2019 than when it began, and the most-recent retail sales outcomes point to this deceleration now affecting consumption.
Looking ahead, we expect business investment to remain weak, employment growth to soften further and consequently the recent subdued pace of household spending to persist through 2020. To our mind, this will justify further US rate cuts in 2020 as growth falls below trend and inflation remains at or below their 2 per cent target.
While 2019 Chinese GDP growth of 6.1 per cent, revealed today, was a near three-decade low, the December quarter showed further evidence of a stabilisation in momentum. Importantly, investment growth is broadening across the economy and, in time, is likely to accelerate modestly as Chinese firms expand their Asian export markets and move to higher value-add production.
This opportunity and the flow-on benefit to consumption and housing investment of increasing export income will provide China with an opportunity to grow between 5.5 per cent and 6 per cent in coming years, a multiple of that experienced by the US.
For Australia, the easing of trade tensions is a welcome development despite the potential consequences for some sectors if China is forced to buy from the US to meet agreed targets. But in the medium to long-run, persistent robust growth in China and the rest of Asia will continue to offer Australia considerable opportunity.
This material contains general commentary, and market colour. This material does not constitute investment advice. This information has been prepared without taking account of your objectives, financial situation or needs. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts. Except where contrary to law, Westpac and its related entities intend by this notice to exclude liability for this information.