UK Elections and US-China trade: Removing Risk Factors

Following the euphoria over the decisive UK election result and the US/China "Phase 1" trade deal markets look primed to end the year on a positive footing. Two of the major risk factors threatening to detail market sentiment into year end have at least been lifted. However, some reality may begin to set in early into 2020, with investors recognizing that there are still major issues to be resolved both between the UK and Europe and between the US and China,

Although full details have yet to be revealed, Chinese officials will likely be relieved that the hike in tariffs scheduled for December 15 will now not go ahead. However, there are still questions on how China will ramp up its purchases of US agricultural goods anywhere near the $40-50bn mark that has been touted.

Also the dollar amount of the roll back in US tariffs is relatively small at around $9bn, which hardly moves the needle in terms of helping China's growth prospects. "The United States will be maintaining 25 percent tariffs on approximately $250 billion of Chinese imports, along with 7.5 percent tariffs on approximately $120 billion of Chinese imports." This still means that a substantial amount of tariffs on Chinese goods remains in place.

According to Trade Rep. Lighthizer, the deal will take effect 30 days after its signing, likely in early January. To sustain any improvement in sentiment around trade prospects there will need to be some concrete progress in removing previous tariffs as well as progress on structural issues (state subsides, technology transfers etc) in any Phase 2 or 3 dealss. The bottom line is that agreement in principle on "Phase 1" will need to be followed by further action soon, otherwise market sentiment will sour.

In the UK Prime Minister Johnson now has the votes to move forward with Brexit on January 31 but that will leave only 11 months to negotiate a deal with the EU. The transition period finishes at the end of 2020 unless of course there is an extension, something that Johnson has ruled out. In the meantime the immediate focus will turn to the next Bank of England governor replacing Mark Carney. This decision could take place this week. Markets will also look to what fiscal steps the government will take in the weeks ahead.

GBP has rallied strongly over recent days and weeks, extending gains in the wake of the Conservative Party election win. However, further gains will be harder to achieve given the challenges ahead. UK equities have underperformed this year and are arguably relatively cheap from a valuation perspective, but further gains will also involve removing or at least reducing much of the uncertainty that has kept UK businesses from investing over recent months. In the near term GBPUSD could struggle to break above 1.35 unless there is progress on the issues noted above.