US and China signal temporary de-escalation in trade conflict

What happened?

A pivotal meeting between the US and Chinese presidents has ended with an easing of tensions over trade and a commitment to further negotiations. The White House said it was willing to delay a 1 January increase in tariffs on USD 200bn of Chinese goods, from 10% to 25%, while negotiations continue. In return, China agreed to purchase a "very substantial" amount of US farm, energy, and industrial goods. Talks will begin over intellectual property theft and the forced transfer of technology, with a three-month deadline. Failure to agree terms will result in a renewed rise in US tariffs on Chinese goods, the White House indicated.

At this time, markets view the news as modestly positive for risk assets. Global equities rallied late last week on both optimistic signs for the US-China meeting and the perception that the US Federal Reserve is becoming more flexible around further rate hikes.

In other news from the G20, there were further indications that OPEC and Russia will co-operate to stem the recent slide in crude prices. The weekend also marked the signing of an agreement to replace NAFTA, though the deal will now need to be ratified by the legislatures in the US, Canada, and Mexico. Finally, US markets and the federal government will close on Wednesday 5 December in observance of a National Day of Mourning after the death of former US President George H.W. Bush, who passed away on November 30 at the age of 94.

What does this mean for investors?

While President Trump described the bilateral meeting with China as "amazing and productive," we believe the rivalry between the US and China will not be easily overcome, especially over the issue of intellectual property and market access. A breakdown of talks will remain a risk for markets and the global economy. US trade relations with other partners also remain tense, and we will continue to monitor the White House threat to impose additional tariffs on car imports, which would represent a significant headwind for the large German and Japanese auto sectors.

However, the delay in the tariff rate increase is a positive development relative to our base case and the meeting managed to avert a significant escalation that could have deepened the recent sell-off in global equities. A negative outcome could have included the swift imposition of a third round of US tariffs on an additional USD 267bn worth of Chinese goods. This further round of tariffs would have targeted China's higher value-added IT products and inflicted greater disruption on global supply chains.

What does this mean for our positioning?

The outcome of the G20 meeting supports our moderate risk-on stance. We added to our overweight in global equities after November's US mid-term election on the view that markets had adjusted to better reflect concerns over slower economic growth and the escalation of the trade conflict. In the past week we have learned that both the Trump administration and the Federal Reserve are not dogmatically pursuing policies without regard to the market and economic impact. We remain overweight global equities and US-dollar denominated emerging market sovereign bonds. Yet we also continue to expect heightened volatility around policy and economic news. As a result, our equity overweight is balanced with counter-cyclical positions – including an overweight to 10-year US Treasuries and the Japanese yen versus the Taiwanese dollar.

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