G20 Preview: What to Watch from Trump and Xi’s Massive Meeting
June 24, 2019 1:56 PM
Despite their international cachet, G20 meetings rarely lead to noteworthy market movements, but this week’s summit in Osaka looks like an exception to the rule.
It’s been nearly a year and a half since the Trump Administration first enacted tariffs on Chinese goods, and despite eleven rounds of negotiations, the two sides have not been able to reach a trade agreement.
Frustrated with the lack of progress despite months of negotiations, President Trump dramatically raised the stakes by vowing hike tariffs on $200B of Chinese imports from 10%-25% last month. He also indicated that he was considering implementing 25% import taxes on $325B in Chinese imports that are not presently penalized. While China does not import enough from the US to raise tariffs in lockstep, it has been cutting tariffs on other countries as well as threatening to cut off rare earth metal exports, dump treasury bonds and cease US agricultural purchases.
While many companies have been able to cushion the blow so far by stockpiling goods ahead of the tariffs, continued escalation of the trade war between the planet’s two largest economies represents perhaps the biggest threat to global growth in the coming quarters. Economists have estimated that if all announced tariffs were fully implemented, it would reduce long-run US GDP growth by 0.8%; for reference, the Atlanta Fed estimates that the US economy is on track to grow at a 2.0% annualized rate this quarter.
Potential Market Impact: What to Watch at the G20 Summit
As with many conferences, the most interesting developments from this week’s G20 meeting will take place on the sidelines, rather than as part of the official agenda. Specifically, traders will be watching the tone of the trade negotiating teams and any signs of progress in the conversations between Presidents Trump and Xi around the ongoing trade war. This will represent the first official trade dialogue between the two global superpowers since talks collapsed in early May.
Simply put, the trade relationship between US and China has a massive impact on nearly every traded market around the globe. Heading into the summit, we see one of two general scenarios playing out:
1) Trade Talks Fall Apart, Trade War Escalates Further
In this scenario, the US and China are unable to issue a joint statement citing progress in discussions. From here, the US may carry out on its threat to enact tariffs on the last $300B of Chinese imports while China pursues countermeasures of its own.
In our view, this is the less likely of the two scenarios (and with global equity indices within striking distance of record highs, it seems most investors agree). That said, it would immediately raise the likelihood of a coordinated global slowdown if seen.
If the US opts to impose the threatened tariffs (essentially doubling taxes on Chinese imports, including many consumer goods), relatively insulated indices including the S&P 500, DAX and FTSE could nonetheless see a 5-10% drop moving through the summer, with more severe drops likely in China-linked indices such as the KOSPI, ASX200, and Hang Seng. Given their reliance on rare earth metals from China, semiconductor, automobile suppliers and other larger industrial manufacturers may be hit especially hard.
Beyond equities, a negative outcome would also represent a headwind for higher-yielding currencies such as the Australian and New Zealand dollars while boosting demand for safe haven assets such as the US dollar, gold, and US treasury bonds.
2) Positive Tone to Trade Talks, Conversations Scheduled to Continue in July
A full trade agreement this week is almost certainly a bridge too far, so investors would view a Trump-Xi handshake and a commitment to resume talks as a positive outcome. In this scenario, the US agrees to delay threatened tariffs (or ideally remove some of the already-imposed tariffs) in exchange for small concessions from China.
The market reaction may be more muted in this scenario, though we would expect to see global indices react positively, potentially taking some of the stronger indices such as the FTSE and S&P 500 to new record highs. Meanwhile, traders would likely begin rotating out of more conservative assets like gold, bonds, and the Japanese yen in favor of China-linked cyclical investments such as the antipodean dollars and industrial metals.
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While a constructive conversation and resumption of trade talks looks more likely at the moment, we could see far more explosive market moves if President Trump “walks away” from the talks, as he did with North Korea earlier this year.
One way or another, this week’s G20 meeting is one that all traders should have on their radars!
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