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Latest U.S.-China Trade Truce Is a Temporary Support

Wells Fargo Investment Institute - October 14, 2019

Key takeaways

  • On October 11, China and the U.S. announced a modest first step towards a trade deal.
  • The deal is narrow and vague on details but cheered global equity markets.

What it may mean for investors

  • In our view, this new truce is likely only a temporary support for equity markets and does not justify taking on new portfolio risk. We have reduced portfolio risk exposure systematically and thoughtfully over recent months and are not altering our current investment strategy.

As of October 11, the U.S. and China announced concessions in their trade dispute. China agreed to buy $40–50 billion in U.S. agricultural products over the next two years. In return, the U.S. waived a small increase in tariffs set to take effect on October 15. The two sides reportedly discussed China’s intellectual property and currency policies, but no details have been released. President Trump referred to the agreement as a “Phase 1” deal. 

We view this as an underwhelming step forward. The terms offer less than what was on the table before the talks broke down in May. China needs the agricultural products in any case, and the U.S. conceded only minimal tariff relief in exchange. The agreement leaves intact the past 18 months of tariffs, as well as the tariff hike scheduled on December 15. In light of what the two sides could have done, this “Phase 1” agreement seems more like a temporary truce.

Our perspective is that the truce was the least that the two leaders could accept under growing political and economic pressure. We wrote in May that the two sides might achieve a partial deal, if their economic data deteriorated over the balance of 2019.1 That pressure has developed. A report on Chinese economic growth for the third quarter, due later this week, probably will show a continuing slowdown in China. Meanwhile, weakening U.S. manufacturing appears to be spreading to U.S. services industries. In addition, both leaders are under political pressure: President Xi because of protests in Hong Kong and President Trump because of the impeachment inquiry. 

Can stronger economic growth build on this truce?

Global equity and other risk markets responded positively to the announcement of the latest trade truce. The Federal Reserve’s (Fed) decision to provide additional liquidity to the banking system also cheered markets on Friday and should reassure investors with money-market holdings as well as the financial system more generally. 

We believe the trade truce and the Fed decision are better than nothing, but some perspective is in order. The Fed will expand its balance sheet to provide more liquidity, but not to reprise its large-scale buying from earlier this decade. And aside from its vague terms, the trade truce is most remarkable for ignoring both the increasingly damaging tariffs already in place and the punitive non-tariff measures announced by each side—even as recently as the days before the latest truce. 

So far this year, there have been several U.S.-China trade truces, generally shortening as they have accumulated. But the main issues remain: China wants to become the global leader in technology, while the U.S. wants to block the challenge. We foresee more escalation as the recurring theme, punctuated by temporary truces, for as long as the negotiators do not engage the main issues. The latest trade truce looks like a glass half-full, but the risk of a spill does not justify taking on new portfolio risk, in our view. We have reduced portfolio risk exposure systematically and thoughtfully over recent months and are not altering our current investment strategy.

Download a PDF version of this report

1For complete details, see WFII Institute Alert, “He Said, Xi Said: Can There Be a U.S.-China Trade Deal?” published on May 28, 2019.