US-China Trade: 60% Chance of Ceasefire at Xi-Trump Meeting

Key points

• Trump signals he may be ready for a trade war ceasefire at the Xi- Trump meeting on 1 December.
• This is positive for markets and the global economy, as it reduces the probability of a very negative scenario of a prolonged and worsening trade war.
• We now see a 60% probability of a ceasefire but any real deal will take time to reach and is not likely to be done until some point in 2019.

The big news yesterday on the trade front was US President Donald Trump’s tweet about a long and good conversation with Chinese President Xi Jinping. It was followed up by US sources saying that Trump had instructed his trade officials to start drafting potential terms for an agreement. According to Bloomberg, Trump had asked cabinet secretaries to draw up a potential deal to signal a ceasefire.

What to make of this

We do not know any details of the conversation between Trump and Xi but it comes shortly after Trump had been threatening that if there were no agreement at the meeting, he would escalate the trade conflict further and put tariffs on all Chinese imports. The new signals are clearly more positive and we believe we have moved from a 50-50 probability of an agreement to restart talks after the meeting to a 60-40 probability.

What would an agreement look like?

We should not expect a final deal on trade but instead a kind of ceasefire agreement like the one Trump has made with the EU, which paves the way for a new round of high-level talks. The agreement should pencil in clearly the US’s demand. China has signalled confusion over exactly what the US’s requirements were and who was the chief US negotiator with a mandate to make a deal. When China thought they were in serious negotiations in May, US Treasury Secretary Stephen Mnuchin was leading the US delegation. He is regarded as softer than the other members of the trade team – Peter Navarro and US Trade Representative Robert Lighthizer. When Trump decided to leave the negotiations, it was seen as a win for the hawks and as undermining Mnuchin’s role.

What has changed?

Until now, we had expected Trump to go all the way and put tariffs on all Chinese imports before making a deal. He has said several times that now is not the time to talk to China and so far he has done everything he has threatened to do. In addition, looking at his history of making deals, he uses a ‘maximum pressure’ tactic and as he wrote in his book Art of the Deal he keeps ‘pushing and pushing and pushing’. In China’s case, this would imply going all the way on tariffs. He has also felt he had more leverage than China to ‘push’, because he has more imports on which to put tariffs. However, to use this leverage he would need to go all the way. He has seen confirmation of the stronger US position in the increases in US equity markets relative to Chinese markets and robust US growth compared with Chinese growth. So, what may have changed his view?

First, US markets have started to correct too, which is reducing some of his relative strength. Second, the US economy is also showing signs of moderate slowing. Yesterday’s ISM index saw a quite big fall in new orders driven by exports. Finally, if Trump escalates further, we cannot rule out that it would start to have a bigger impact on the US markets and economy as well, especially if business confidence starts to take a hit. So far, his tax cuts have supported the economy but what about when this starts to fade? A slowing economy could weaken Trump’s hand. Thus, it may be that Trump has decided that now is the time to talk to China because the relative strength may be at a peak. We do not know whether that is how he thinks but, in our view, it could be a possibility.

Another possibility is that he just wants to soothe the markets ahead of the midterm elections next week and that he will revise his opinion again. We can imagine China fearing this. In general, we believe it will be very careful not to set expectations too high and give away too much in the short term, because it has seen several times now that what it thought was an agreement turned out not to be, with a loss of face domestically.

When and how?

The latest reports suggest Trump has offered Xi a ‘meeting plus dinner’ on 1 December, once the G20 meeting is over in Buenos Aires (see SCMP). This is a change from the previous unofficial reports that a meeting would take place on 29 November before the G20 meeting.

What does it mean for markets and the global economy?

If Xi and Trump manage to make a ceasefire agreement, it would be positive for risk sentiment. Markets have already priced some of this in advance but confirmation of a ceasefire would add further to the upside potential. It would also dampen some of the uncertainty for businesses.

However, a ceasefire is no guarantee of a quick deal. Some big obstacles for a deal are in place, not least when it comes to China’s ‘Made in China 2025’ strategy, which we do not expect China to change in any significant way. A real deal will take time to negotiate (just look at the US deal with Mexico and Canada and the ongoing negotiations with the EU) and there are likely to be setbacks along the way – as in most other negotiations. So, volatility is likely to remain but, ultimately, we do expect a deal to be made at some point in 2019.

As the trade war has been one of the big dark clouds hanging over markets and the global economy, it will be positive if, and when, we have a deal. Less trade friction between the US and China would be positive for potential global GDP growth.