Xi-Trump meeting yields a “pause” in tariff escalation as US postpones deadline by two months

Presidents Trump and Xi dined together on 1st December in Argentina on the sidelines of the G20 meeting. Shortly after the meeting both the White Houseand China’s Xinhua news agency issued statements with a positive tone, indicating “both presidents thought the meeting was highly successful”.More importantly, President Trump agreed to delay the planned rise in the tariff rate on $200bn of imports from China from 10% to 25%. That step-up had been scheduled to take effect January 1, but has been delayed until 90 days from the time of the meeting, or March 1. During this time, the White House statement states that it expects the two sides to engage in more detailed “negotiations on structural changes with respect to forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture”. If the two sides do not reach an agreement in 90 days, the White House states that tariffs will increase to 25%. Effectively, then, this is a two-month extension to allow more time for negotiation from the current January 1 deadline.

Post-meeting statements suggested tentative agreements on a few less controversial issues:

There appears to have been no concrete progress on the other important issues of market access, IPR protection, cyber attacks, and forced technology transfer (the latter two US concerns have always been denied by Chinese policymakers) which are left for working level officials to work out in the next 90 days. So the actual amount of concrete progress made at this meeting appears to have been quite limited, as expected. This “ceasefire” is good news for China as it gives policymakers more time to stabilize the domestic economy which has been weakening (the latest reading for our China Current Activity Indicator is 5.8%, down from an average of 7.5% in the first half of the year). There have been heightened concerns about a further slowdown around the Chinese New Year as most industrial and construction companies will suspend production and then restart and rehire workers after the festival. Given the state of the economy many—including policy makers—are concerned about numerous longer-term shutdowns at that time. Unlike the downturn between 2012 and 2015 which saw upstream companies, a large share of which are SOEs, suffering more, this time the pressure is disproportionately on downstream companies, which are mostly private. Unlike SOEs, when private companies close the impacts on employment and NPL tend to be much more visible. As such we expect the Chinese government to continue its loosening measures.

While the Xi-Trump dinner has clearly improved the tone of the US-China relationship for the time being, and we would expect an initial positive market reaction, the “pause” prolongs the period of uncertainty around the eventual structure of trade relations between the two countries. The specter of higher and broader US tariffs remains, and the underlying issues clouding the trade relationship are deferred to further negotiations. With additional time to pursue negotiations, we think the chance of a comprehensive deal that involves rollback of tariffs is slightly higher than before, but still  a 20% probability over the next three months. However, the two most likely outcomes in our view continue to be a continuation of the “pause” that was just announced— i.e. a partial agreement that forestalls further escalation but does not eliminate existing tariffs—or incremental escalation, involving the eventual step-up to the 25% tariff rate on $200bn of imports already subject to 10%. While it is a close call which of these is more likely, at the margin it seems slightly more likely  that the talks will falter when they reach more difficult issues and that the step-up to 25% will still occur in March or beyond. That said, between the possibility of a continued “pause” and the possibility that an agreement is reached after the step-up to 25% occurs , the probability of tariffs on imports from China beyond the $250bn already affected has decreased in our view.

How markets and domestic political sentiment react to this weekend’s statements may influence the willingness of both sides, particularly President Trump, to reach a deal in the future. Of course, to the extent either country sees the other as particularly keen to make a deal, its policymakers may try to drive a harder bargain, making an eventual compromise more difficult. Regardless, the US-China announcements nevertheless send a constructive signal regarding the eventual outcome of these talks, and strengthen our view that President Trump is likely to want to conclude an agreement—even if it does not include a full rollback of tariffs—well ahead of the 2020 presidential election.