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Curatia Analysis for Mon, Mar 11

Trade Wars Volume XXIII: US-China Pact May Offer Markets Little More Than a Sugar High

While the Fed’s decision to pause rate hikes is largely behind markets’ blistering start to 2019, an easing of US-China trade tensions has also played a role. But with détente seemingly in reach, financial media have voiced growing skepticism over the potential for an agreement to bend the status quo.

That distinction may not faze markets, which are collectively more concerned with the trajectory of global economic growth than how the pie is divvied up. Nonetheless, markets’ anticipation of a US-China trade pact, the potential for a resumption of Fed rate hikes, and the specter of a trade-war sequel could all dampen market enthusiasm for an agreement.

US and Chinese officials have signaled progress in trade negotiations of late. The Trump administration delayed a tariff increase slated for March 1. Chinese central bank governor Yi Gang said the countries had reached consensus on many vital issues. And Donald Trump offered to host Chinese President Xi Jinping for a trade agreement signing summit.

Those developments come as evidence mounts that trade wars are hitting the US economy. Economists last week found that tariffs were costing US consumers and companies $4.4B a month in tax costs and deadweight losses. The numbers did not factor in delayed company investments.

But even as inertia toward détente builds, financial media have increasingly questioned whether a deal can deliver “any truly transformed trade relationship.” The US and China have haggled over enforcement of Chinese trade commitments including stricter rules enforcing intellectual property rights and a pledge not to manipulate the yuan.

Whether the US will eliminate recently imposed tariffs on day one of the agreement or take a wait-and-see approach is also at issue. Those complexities have US officials adopting a “more cautious” tone, with the likelihood that a firm agreement won’t come until April or later.

They also highlight running risk of a breakdown in negotiations — something strategists at Morgan Stanley Wealth Management said last month markets weren’t sufficiently wary of.

Ironically, questions over how the global trade pie is sliced are likely less consequential for markets than the removal of tariffs, which have contributed to stagnating global growth.

Another key question is the extent to which markets have already baked in the potential rewards of a US-China trade deal. The S&P 500 has risen 10.2% since December 24. Before Friday’s 4.4% pullback, Chinese markets were arguably looking overbought after adding nearly $2T in value in recent weeks.

Markets have almost certainly prefigured tariff rollbacks and the encouraging effect an agreement could have on business investment, which has slowed considerably amid macroeconomic uncertainty.

What is less clear is whether investors have anticipated the forces that could dampen market enthusiasm post-deal. A rebound in global growth, for example, could reboot the Fed’s rate hike schedule.

And with another year to go before electioneering resumes in earnest, the Trump administration may opt to redeploy its China tariff campaign blueprint against the EU, assuming any agreement with China polls favorably with the American electorate.

Following “contentious exchanges” with Mr. Trump in a February meeting, Austrian Chancellor Sebastian Kurz said the US leader “‘has it in for Germany’” and said the EU “‘can’t rule out that tariffs will come.’”

US-EU trade tensions would strain the ties of global trade in new ways and could send the eurozone’s tottering economy over the recessionary brink.

Given those countervailing factors, the risks in US-China trade negotiations could outweigh the rewards from a market perspective at present. As such, any bump in global stock prices owing to a US-China trade pact could prove fleeting.