Summary: Forex markets have settled into apparent equanimity over the Sino-US trade war, while equities have regained some composure following Monday’s rout. But this complacency looks misplaced as the diplomatic standoff could run and run…
Before we sound the all clear on this recent bout of volatility, we can’t forget that the current diplomatic standoff plays into both sides' hands. As we noted last week,Trump needs to push hard on China and no deal is almost better than a bad deal at this stage. “The fight is more important than the resolution,” stated one of Trump's senior campaign officials.
With anti-China sentiment growing in the US and the trade negotiations under the global spotlight, the onus is on Trump not to squander this opportunity and to push hard against China. Trump also has more ammunition to stand firm, relative to last year, now that the Fed is no longer on autopilot with raising interest rates. Xi also can’t appear to be strongarmed by the US, particularly in this politically sensitive year (the 70th anniversary of the PRC). This means the conclusion of the trade deal could still be several months away, longer than markets anticipate thus allowing for a prolonged period of uncertainty, a risk that could be underpriced.
The stakes are high, neither side wants to lose face, but neither would be willing to suffer too much economic damage. Until stocks are lower or economic weakness is pervasively visible the incentive to compromise is perhaps some time away – another reason to avoid complacency. Or perhaps, being purely speculative, that is really the president’s true game, maybe he can suffer some market weakness then bully the Fed into cutting interest rates.
Whilst we game out the brinksmanship between the two sides data out of China today again confirmed the fragility of the Q1 recovery, something we have noted several times before.
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