Why One Bank Thinks Trade Truce Will Give China More Leverage

Well, if you want to go by early Asia-Pac FX trading (which is an exceptionally silly thing to do), markets are feeling pretty good about the trade truce.

In the earliest of early trade, the Aussie rose, the offshore yuan rallied against the dollar. and the yen was weaker.

(Bloomberg) 

Obviously, these aren’t the most reliable ticks to go by, but it was a decent start and seems to underscore the notion that the initial read on what came out of dinner in Argentina is that the agreement marks a reasonably convincing step in the right direction.

Meanwhile, more commentary from the sellside is starting to trickle in. The mood there is cautious.

“We take the development as moderately positive for the next 90 days, but it does not address any of the structural issues in bilateral relations”, Deutsche Bank writes, in a short piece. As far as what the bank expects going forward, they assign a 40% chance to a sustained truce and improved relations beyond the initial 90-day window and a 60% chance of further escalates after that.

Remember, the White House said Saturday that if no progress is made after 90 days, the tariff rate on the $200 billion in goods that were taxed at 10% in September will jump to 25%, as originally planned.

Deutsche also says the reprieve, even if short-lived, will help China’s bargaining position. “The tariffs already imposed may push up retail prices in the US, incurring pains for households and corporates [so] the longer the truce exists, the more bargaining power China may gain in the negotiation”, the bank argues.

While the interim agreement may mean China won’t be forced to ease aggressively in the near-term, Deutsche is sticking with their call for USDCNY at 7.40 by year-end 2019. They also reiterate their expectation for three more RRR cuts next year.

This is likely to be the consensus from most analysts. It’s far from clear that 90 days is enough time for Washington and Beijing to settle the array of complex issues at the heart of the dispute and ultimately, China will be forced to support the domestic economy amid an ongoing deterioration in the data.

That said, the U.S. economy is likely to decelerate meaningfully going forward as the fiscal impulse fades. And if tariff-related price pressures do start to materialize while wage growth continues to move up, it will mean margin pressure for corporate America and, crucially, could make the Fed more reluctant to pause the hiking cycle.