The G20, where the world's two largest economies will go head to head

The G20 summit in Japan on the 28-29 June will take the center stage this weekend as the world’s two largest economies remain locked in an ongoing trade war.

US President Donald Trump and Chinese President Xi Jinping are expected to meet on Saturday since trade talks broke off in May after the Trump administration hiked tariffs to 25% from 10% on about $200 billion worth of Chinese imports and China retaliated with higher tariffs.

President Donald Trump has also threatened to impose tariffs on an additional $300 billion of Chinese imports.

China and US trade officials are already talking ahead of the Trump-Xi meeting, which raises hopes for an easing in trade tensions, as both economies have been recently showing signs of weakness. Both countries want a deal and Donald Trump does not want to weaken the US economy before the 2020 election.

The stakes are clearly high. This G20 summit will set the future direction of negotiations and will determine market trends and Central Banks’ reaction in the coming weeks and probably for the second semester.

Central bankers have already signaled that they are ready to act quickly if need be and to ease monetary policy further to support economic expansion, as downside risks to the global economy remain elevated.

In the US for example, the Fed is expected to cut the federal funds rate by 25bp or 50bp (Source: Bloomberg) in the next meeting in July and the magnitude of the cut will depend on the outcome of the G20.

So what can be expected, what could be the most likely outcome and the market’s reaction?

We have identified 3 potential scenarios:

  • A Ceasefire (hold off on additional tariffs): both sides agree on a truce (for a fixed period or not). Trade talks resume.
  • A deal (de-escalation): both sides agree to reach a mutually satisfying solution with the gradual removal of a portion or most of all existing tariffs
  • Escalation: Trade talks fail. New tariffs could be imposed by the US on part or all of the remaining $300 bn of Chinese imports in the third quarter. The Trade war escalates.

A deal that satisfies both countries remains in our view unlikely is at this stage. We discard this possibility that we consider too optimistic. But if it were to be the case, the market reaction could be very positive with a very strong rally in risky assets (equities markets, both EM and DM, High Yield Credit) coupled with a sharp increase in core yields as investors will reassess their views about the dovish messages formulated by Central Banks. The Chinese equity market and EM assets would benefit the most.

The most likely outcome is a ceasefire as both sides are expressing a desire to resume talks. The US agrees to hold off on additional tariffs and to reinitiate negotiations. This outcome remains market friendly but is already well priced in by the market. The US stock market is near its all-time high. So, we think that the market could react positively, but the reaction might be muted. We do not foresee a strong rally in developed equities markets. It should provide more relief mainly for EM assets and would likely benefit the most trade sensitive names that have suffered and underperformed during the last weeks. Core government bonds are expected to sell off initially for a short period of time.

However, we can’t exclude the escalation scenario which implies a failure in negotiations. In such a case, the US would continue to put pressure on China by imposing more tariffs. It would be very bad news and business confidence would deteriorate more quickly, dragging on the global economy. This outcome would be clearly very risk off for the markets and imply a more prolonged period of uncertainty. All risky assets would sell off sharply and safe-haven assets would rally strongly (US treasuries and gold mainly) as markets would price in a full trade war and world recession in the coming months. We think that this is the least likely scenario, because it would have very strong negative economic impacts for both countries and the global economic growth outlook.

All that being said, I will say that we remain cautious before this meeting as it is very difficult to predict a political outcome. But, if the trade war escalates, global growth is expected to be cut by roughly - 70bp according to a macro economist consensus.

Hervé Chatot July 2019



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