China: from escalation to de-escalation

Danske Research Team Danske Bank A/S

With the prospect of a US-China phase one deal we have moved from 11/2 years of trade war escalation to a phase of de-escalation. This is good news for the global economy.

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Phase one deal to mark a change to de-escalation

US President Donald Trump brought a sigh of relief in markets on Thursday when he turned to his favourite channel of communication and tweeted ‘Getting VERY close to a DEAL with China. They want it, and so do we!'. Later sources close to the trade talks in Washington said that a phase one deal had been reached. Michael Pillsbury, a close China adviser to Trump, said to WSJ that ‘The president is upbeat and enthusiastic about this break-through'.

What's in the deal? At the time of writing no official statements are out but the sources point to 1) China buying agricultural goods, energy and other goods worth USD50bn in 2020, 2) US rolling back tariffs on USD360bn by 50%, 3) China tightening protection of intellectual property rights, 4) China opening up more for financial services and 5) a currency agreement implying no devaluation of USD/CNY, 5) a ‘snap-back' clause that gives the US the right to put tariffs on China again if the deal is breached.

Comment. A phase one deal will mark a shift in the US-China trade war from 11/2 years of escalation to a de-escalation phase. This is what we believe is important from a market point of view as it reduces the global recession risk further and underpins a recovery in 2020 in both China and the global economy. Why now? As we have argued, we believe the US election in less than a year is the main reason Trump is now eager to close a deal.

The next question will be if the two sides can close a phase two deal as well in the first half of 2020. This will be more difficult and may depend on how Trump is looking in opinion polls. Republican Marco Rubio and Democrat Chuck Schumer have already been quick to criticize the phase-one deal for not dealing with the real problems with China. Hence, Trump will be under pressure to close a phase two deal as well. We still put the probability of this happening at 50%.

Stock markets and the CNY gained on the news of a deal. We see further upside in both markets, with Chinese stocks likely to reach new cycle highs soon and the USD/CNY moving gradually towards 6.8 over the coming year.

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Danske Research Team

Danske Bank A/S

Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.

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