US-China trade talks – a tweet too far?

It is highly likely that this is a negotiating tactic by the US to raise the stakes and will go down well with Donald Trump’s core base of supporters by showing how tough he is. With the US economy and equity markets doing relatively well he probably concluded that he had considerable leeway to step up the game of bluff with China.

However, it also raises the real possibility that the trade talks will end in failure with the Chinese concluding that they would lose too much face negotiating under duress. This would dramatically escalate the trade dispute leading to uncertainty in the global economy once again. There are hawks in the Chinese government that believe that China has given away too much already and will balk at any further concessions.

Our base case remains that the US and China would prefer to agree to a trade deal since both countries need a deal for different domestic reasons. There is also considerable pressure from US and Chinese business groups who need a trade policy to create certainty and stability. The existing tariffs have been disrupting supply chains and impacting competitiveness.

Note that the trade deal does not need to be perfect, and it most likely won’t be. It just has to be good enough to scrap the tariffs that were imposed over the course of 2018. Any deal is likely to leave a lot of unanswered questions in the short term, whether they relate to the actual execution, the future of technology transfers, or any follow-through on a US-Europe trade deal. That said, any deal is unlikely to be as bad for the global economy as the prospect of 25% tariffs on all goods traded between US and China.

However, it is unquestionably the case that tail risk has increased significantly as there is a real danger that Trump has underestimated the importance of ‘face’ for China and overplayed his hand. In this worst case scenario we would expect the markets to be rattled and negatively affected. As mentioned in the recent quarterly outlook by Fabiana Fedeli, for markets to continue to rally, a US-China trade deal is necessary.

We will be watching developments very closely in the following days, but for now we stick to our long term base case and will not be changing our current portfolio positioning, as portfolio action at this point would be speculative in nature. We find it positive that despite the criticism directed at China, the commerce ministry has stated that the vice-premier Liu He would still arrive in Washington on Thursday for an abbreviated round of talks.