Short And Sharp: G20 U.S./China Talks, There's More Than Meets The Eye

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by: Principal Financial Group
Summary

Comments from various members of the U.S. administration in recent days seem to have lulled markets to expect some kind of breakthrough from trade discussions with China discussions at the G20 meeting.

China's markets are struggling to regain their footing, indicating that perhaps President Xi has more pressure to reach a deal.

But upcoming national events suggest the opposite could be true.

If U.S./China trade tensions do escalate further, the global growth outlook will darken meaningfully, central bank stimulus will surely struggle to undo the damage, and risk assets may tumble.

By Seema Shah, Global Investment Strategist, Principal Global Investors

Positive - but empty - comments from various members of the U.S. administration in recent days seem to have lulled markets to expect some kind of breakthrough from trade discussions with China discussions at the G20 meeting. The various challenges that exist on both sides would suggest markets would do well to be a little wary.

For President Trump's part, with equities at record highs and the Federal Reserve poised to provide an additional monetary boost, there is less urgency to agree a deal than there was a few weeks ago. Admittedly, China's markets are struggling to regain their footing, indicating that perhaps President Xi has more pressure to reach a deal. But upcoming national events suggest the opposite could be true.

Later this year, on October 1st, will be the 70th anniversary of the creation of the People's Republic of China, a politically important event with meaningful implications for both the Chinese economy and U.S./China trade talks.

Recall that, in 2017, the year of the 19th Party Congress, Beijing put together fiscal spending equivalent to 0.5% of GDP in the first three quarters of the year - policy action that contributed to their eventual decision to start deleveraging later that year. Similarly, in the run-up to the 70th anniversary, policymakers will be keen to show China's economic strength - further fiscal and monetary easing are likely in the coming months. Having said that, currency depreciation is unlikely to feature in the toolkit, as a strong and stable renminbi will be a source of national pride.

What's more, not only will China be looking to present a strong economy, it will also want to project its geopolitical strength. This implies few concessions to the U.S. and an uncompromising intent to protect China's national corporate champions. Given the US administration's determination to paralyse China's technology super-power aspirations, this may also be non-negotiable for President Trump. Markets should be more cautious.

If U.S./China trade tensions do escalate further, the global growth outlook will darken meaningfully, central bank stimulus will surely struggle to undo the damage, and risk assets may tumble. Technology stocks would sit directly in the firing line, with chipmakers the most vulnerable to a breakdown in talks.

On the other hand, if there are signs of high-level progress, eyes would quickly turn to the July Fed meeting. Would the Fed back away from its promised rate cut? After all, the original decision to signal further stimulus, rightly or wrongly, was clearly in response to growing trade uncertainty and the risk to business sentiment and capex. As the equity market is now fully pricing in a 50 basis points cut, market disappointment could be significant. This is a reaction the Fed will surely be desperate to avoid.

And if the Fed follows through with a cut despite a brighter trade outlook? Beyond the knee-jerk euphoria, expect minimal market reaction - this last scenario is exactly what the market is already expecting.

Plus, who's to say President Trump doesn't change his mind about China again in a few weeks? A technology cold war is underway; do you really think Trump would capitulate at this very early stage?

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.