The US government announced in late February a delay to the March 1 deadline to increase tariffs on Chinese products following trade negotiations between the two countries. And hopes are running high for a trade agreement to be reached sometime later when leaders of the two countries meet.
What could a deal look like? The details of any China-US trade deal will likely only be finalized and released at or after the next meeting between Chinese and US leaders. Our best guess is that a broad agreement could be finalized. In the case of a broad deal, US restrictions on the Chinese tech industry may be less severe than otherwise might have been.
What can be claimed or observed in the near term? For China, the US will not increase tariffs on imports from China on March 2, and it will agree to continue negotiations and may even agree to gradually roll off some existing ones. In addition, the US may move to lessen export restrictions against Chinese tech companies in the near term. For the US, China will immediately import more US products (actually imports of soybeans have started), act to enhance intellectual property (IP) protection through amendment of Chinese patent law and better enforcement mechanism, roll off of higher tariffs on imports from the US, for example automobiles; and China may expedite the approval of US companies entering into the China market, including in financial services, agriculture and the automobile sectors.
Also, the US will likely demand regular monitoring and verification on areas including China’s commitment on better IP protection and domestic market opening beyond granting of licenses and approvals. Cyber security and international cooperation issues will be ongoing work for both sides. In addition, China will need to observe how the US may tighten and put new restrictions on Chinese investments, Chinese companies, market access, and access to technologies going forward.
What is unlikely to change? No matter how far-reaching (or not) a potential trade deal might be, we do not see China-US trade relations (or general relations for that matter) returning to the conditions before the trade war. Most of all, the US will likely further restrict Chinese investment in the US, China’s access to technology and high-tech products in the coming years.
Also, we expect the US to use the possibilities of higher tariffs, financial sanctions or cutting China’s access to technology as important tools to enforce any trade agreement. As a result, export-oriented businesses operating in China and companies in the China-global supply chains will still face heightened uncertainties. While China is willing to negotiate on many fronts, it is highly unlikely to give up its ambition to move up the value chain and innovate advanced technology. While China may deepen reforms of State-owned enterprise (SOE) reforms, these reforms are likely to be designed to make SOEs more efficient and stronger, not to disappear or privatized.
As for macroeconomic and policy implications, it is forecast that both China’s export and GDP growth will be stronger than our baseline forecasts in the case of a broad US-China trade agreement, rather than a mere extension of the negotiation deadline. However, uncertainty related to potential future tariff increases and/or access restrictions by the US will likely linger and dampen capital expenditure in China. Moreover, policy stimulus may also be held back somewhat as economic activity and confidence rebound.
Also, a trade deal will of course help lift sentiment in the export-related sectors and be positive for the more export-oriented economies in East Asia. A softer export deceleration in China would also help reduce pressure on the job market and on consumer confidence. Specifically, a trade deal will mean consumer electronics and other tech products currently not on the tariff lists will stay off the list. Moreover, to the extent the US will impose less severe restrictions against Chinese tech firms, it will also be positive for the tech supply chain.
Furthermore, a positive resolution on trade talks, while to some extent being anticipated by investors, adds to the better climate for equities alongside a more dovish Fed and better economic data.
While at the market level equities have clearly bounced off their lows partly in anticipation of a trade deal, our baskets of trade related stocks continue to price in a more difficult environment. A positive scenario coming out the trade talks adds to our conviction in our preference for Northeast Asia, especially China, Korean and Japan, over South Asian equities.