US-China trade deal may be impractical, but it is a significant turning point
The phase one deal meets our criteria for a de-escalation in the trade war with its tariff rollback. In reviewing market commentary we believe the significance of phase one is being underestimated. Capital markets respond to changes in second differentials. The trade war as the dominant policy risk for capital markets should now fade. For the real economy, visibility on the supply chain improves, which Navigator thinks will result in higher PMIs and potentially business investment.
There will be numerous practical challenges in implementing the agreement. Note the factsheet states: “The Expanding Trade chapter includes commitments from China to import various US goods and services over the next two years in a total amount that exceeds China’s annual level of imports for those goods and services in 2017 by no less than US$200 billion.” The agreement aims to more than double the US exports of goods and services from US$188bn to US$388bn!
What can the USA sell more than double exports to China? Agricultural exports will not fill the gap. The US National Pork Producers’ Council estimates that the country’s 115 million hogs generate an income of US$20 billion. Approximately a quarter is exported. In 2018, the USA sold US$571 million of pork and pork products to China (source: ustr.gov).
China bought US$18 billion worth of aircraft from the USA in 2018. Boeing’s Commercial Market Outlook 2019–2038 estimates that China will buy 8,090 commercial planes. This works out to 89 wide-body and 299 single-aisle aircraft per annum. At list price, the potential market may be approximately US$60 billion. But in 2018 China’s imports of aircraft were just US$35 billion (source: https://www.export.gov/article?id=China-Aviation). Currently the USA does not have a single-aisle aircraft to sell with the 737Max grounded. Near term, Boeing’s market share of China’s aviation demand is likely to weaken.
The FOMC dots, with three governors forecasting higher rates, contrasts with CLSA’s and Fed Fund Futures expectation of cuts. US financials have rallied on a less dovish Fed. Interestingly, the dollar weakened versus the euro. Fed policy is data dependent with the manufacturing ISM a key indicator. Navigator thinks there is a case for EM financials to play catch-up with US financials.
Finally, the UK election looks to guarantee that it enters an ambitiously short transition period from 1 February to 31 December 2020 in which the UK attempts to negotiate a trade deal and other divorce arrangements with the EU. PM Boris’ deal plus the Scottish Nationalists success in the election adds the risk of separation from Scotland and Ireland.