The major market takeaway from the G20 is the U.S.-China trade truce which defers the imposition of new tariffs from the U.S. and keeps/return the two countries to negotiations. This avoids a negative outcome of tit for tat tariffs in the near term, confirming some recent market optimism, but leaves many unanswered questions.
Among areas that are unclear are is the compromises if any on Chinese Technology (Huwei+), especially on non-U.S. operations, as third countries looking to install Huawei technology are likely to benefit less than U.S. suppliers, details about new IP enforcement and Chinese market access. All of these suggest the trade truce may not last, even if it buys some time including for OPEC and some global central banks including emerging markets. The Truce also maintains a figleaf for growth estimates including those of the IMF which still assume growth will reaccelerate in most markets in 2020 (following the 2019 slowdown). That looks a bit optimistic given the mix of macro policy and productivity enhancing policy. In fact, its striking that most focus at the G20 and other meetings continues to be about short term fixes and can kicking, rather than any real new ideas on long-term growth.
Bottom line: The truce is likely to be positive for risk assets, especially in emerging markets, though much of the anticipated monetary easing is already priced in. Difficulty in addressing technology and other lingering trade disputes are likely to make it difficult for businesses to plan and assess costs. This suggests FX and debt might continue to outperform equity. With markets pricing in extensive rate cuts, driving some of the recent rally, risks are tilted to fed underdelivering.
Agreement eases OPEC decisions, but not the FED
After many delays in setting a date, to the consternation of energy reporters, OPEC ministers meet over the next few days, amid almost universal consensus that the current agreement be rolled over for another 9 months. The trade truce suggests they will feel more confident in their view OPEC+ compliance is helped by the continued pressure on Iranian and Venezuelan output, a trend which is likely to continue, as well as the broad commitment of Saudi/GCC and Russia. The recent upturn in prices following the escalation between the U.S. and Iran is likely to encourage a bit of cheating, but few of those that would want to take advantage of higher prices would be able to. Overall, OPEC+ is likely to keep kicking the can down the road, waiting to see if demand actually does pick up next year – I expect the increase will be modest. Meanwhile U.S. production is likely to keep surprising on the upside, exacerbating some North infrastructure pressure.
The Fed remains in a difficult spot, with markets having priced significant cuts by year end and in 2020, suggesting a market selloff if they do not materialize. The Fed looks set to deliver some of these cuts, especially given its recent rhetoric, but the recent improvement in financial conditions may stay their hand. The political pressures are only likely to increase, extending the risk-on/risk off trend, which suggests picking countries and companies by fundamentals.
Waiting for U.S. China Details, Especially on Tech (Huawei)
Any U.S.-China trade deal must thread the needle between the U.S. security concerns about Huawei and the desire to keep selling equipment to Chinese tech companies… and other goods to China. Chinese counter measures have been particularly effective in reducing commodity imports especially agriculture and in deferring new energy imports. Despite the economic incentives for U.S. companies, security interests suggest that the technology competition is likely to continue and third countries may face the biggest challenges as they are forced to take sides in their supply chains.
It seems likely however that any compromise is unlikely to benefit third countries with significant distribution deals and planned infrastructure with Huawei. U.S. officials, confirming their more mercantilist focus seem to have recognized that its in U.S, interest to allow Huawei and other Chinese entities to keep purchasing chips and equipment, perhaps with some limitations, but that there might still be restrictions that would keep the likes of google reluctant to resume cooperation. Allies are likely to continue to face pressure on Huawei 5G contracts, especially in Europe, Middle East and South East Asia, but that’s a topic for another discussion.
Other difficult issues include subsidies, and other treatment of state owned enterprises as well as areas of enforcement. There are likely many more rounds of trade negotiations to go, and associated tariff threats.
EU-Mercosur a major step, especially symbolically
Speaking of blocs with complicated trade agreements. EU and Southern Cone ministers are celebrating the conclusion of their agreement. After 20 years of negotiation (only the last few seriously), the agreement marks a sea change for closed economies countries like Brazil and Argentina, and is the latest of the significant EU trade diplomacy to bear fruit – all of which clearly benefited from the U.S. attempts to re-write trade rules. The South American countries might significantly reduce their high tariffs, but there are some key political obstacles ahead, including in Argentina where elections loom. Overall, likeminded countries may be able to come together in mutual interest, but it remains to be seen whether this is a game changer in these relatively closed economies.
Lingering over the summer and fall, and awaiting the new commission, are questions about U.S. EU trade talks especially autos and currency/fiscal policy. The EU’s efforts to lock other blocks into their rules, especially EM, is clearly part of their strategy. The challenge is that it’s a region still too reliant on external demand – witness the economic pressure that has come from the recession in Turkey for example, which coincided with weaker domestic demand at home due to relatively tight and very tight fiscal policy.
Given the pressure that many DM are putting on EM to shed or shift their Special and different status in the WTO and lose their benefits in U.S. trade, the details and phase of this deal should be important.
Iran and other geopolitical risks
Other topics like the situation in Iran, Venezuela, debt transparency and quality infrastructure, and many more also came up, but its unclear that there is any real way forward. The last minute Trump-Kim meeting likely overshadowed any other such meetings. A meeting with Iranian officials, less interested in a photo op and more in sanctions relief, would be much more difficult. Expect the situation to remain full of event risk and accidents could risk escalation, even if that’s not intended by principles.
Ziemba Insights 