It took a lot of bullying, badgering and bombast, but Donald Trump got the Fed cover he wanted headed into trade talks with Xi at the G20 next week.
Jerome Powell delivered a dovish surprise on Wednesday and since then, there’s been more than enough dovish rhetoric to reinforce the message.
Thanks to the that, US stocks are back at record highs and the dollar, previously impervious to falling US yields and dovish Fed turns, finally cracked, and is sitting at its lowest since late March.
It’s true that the US economy appears to be cracking, but as long as the bottom doesn’t fall out completely, that’s arguably “good” news in the near-term to the extent it reinforces the case for Fed cuts. On Friday, the Markit manufacturing PMI printed the lowest since September 2009.
Xi comes into the G20 arguably weaker. The Hong Kong protests weren’t the best news for Beijing and virtually all of the incoming data has disappointed. It’s true that China has “tremendous” room (to quote Yi Gang) on both the fiscal and monetary policy fronts, but how quickly stimulus translates to real economic outcomes is debatable. Meanwhile, Chinese stocks have rebounded and the yuan has stabilized.
The question is whether Trump will see the dovish Fed and US stocks at all-time highs as giving him scope to push the envelope further with China or as an opportunity to strike some kind of truce and add a bit of rocket fuel to the rally.
For Xi, the question is how to approach talks with a man (Trump) who is now widely seen as an unreliable negotiator, not above threatening tariffs on a country (Mexico) with which he’s already struck a comprehensive trade deal.
If you ask Goldman, the Trump-Xi meeting will produce “a hiatus but not a “breakthrough”.
“There has been little communication among US and Chinese officials since talks broke down over a month ago, and discussions over the next week seem insufficient to result in a formal detailed agreement”, the bank writes, in a note dated Friday, before underscoring the notion that Trump’s Mexico threats will likely make Xi think twice about a deal. “Chinese officials might also look at the tariffs that President Trump recently threatened on Mexico as a sign that reaching a formal agreement… might not be sufficient to eliminate the risk of tariffs, which would reduce their incentive to offer concessions”, the bank cautions.
Goldman thinks an “immediate escalation” following an unsuccessful G20 is fairly unlikely but, as ever, you can’t rule anything out when Trump is involved.
“In light of the breakdown in talks in early May, there is clearly a chance that the two leaders might be unable to reach even a preliminary understanding”, the bank’s Alec Phillips says, adding that in the event there’s no truce at all, “we expect Trump would indicate that additional tariffs would be imposed, as the time to negotiate an agreement before the 2020 presidential election is growing shorter, and we expect that President Trump would be unwilling to postpone further tariffs if he believed there was little chance of reaching a deal without further pressure.”
On Friday, Global Times editor-in-chief Hu Xijin tweeted the following with regard to what the Chinese side is looking for:
Chinese side is concerned about the fairness of a trade deal. The most important part is the US side must remove all newly imposed tariffs since the trade war. Until now, what I’ve learned is China won’t accept a deal that the US keeps part of the tariffs.
Suffice to say it’s unlikely Trump would be willing to immediately lift all the existing tariffs and, indeed, that’s been a sticking point before. When you throw in the Huawei escalation and the fact that China has now created its own corporate blacklist, the odds of reconciliation appear to be further diminished.
Still, Goldman expects the G20 to produce another agreement that tariff increases will be postponed while negotiations continue. Of course, that leaves open the question of whether the most recent tariff hikes will be rolled back, or whether a “truce” this time just means Trump won’t go forward with duties on the remainder of Chinese imports.
Additionally, another handshake/”we’ll keep talking” deal risks prolonging uncertainty, which, while further making the case for Fed cuts, would likely cast a pall over market sentiment, especially if, in the interim, there are signs that the administration is inclined to move ahead with auto tariffs on Europe.
Goldman still believes that 25% tariffs on another $300 billion in Chinese goods are unlikely. The bank’s base case is a 10% levy on those products before a trade deal is ultimately reached before the 2020 election, although the bank now says that the assumption of a “deal” (and the scare quotes are in the original) prior to the vote is now “a close call”.
Perhaps the most telling section of the bank’s analysis is the short bit on Fed policy, that finds Goldman coming around the notion that Trump has now realized just how effective tariff threats are in compelling Powell to see things the president’s way.
“While it seems unlikely that President Trump had monetary policy in mind when he made the latest round of tariff proposals, we would expect he now views tariff threats as not only a successful negotiating tactic following the immigration agreement with Mexico but also a useful tool in pressing for looser monetary policy”, Goldman writes. “If so, this suggests that the White House will at least threaten further tariff increases and might follow through with some of them.”
Indeed.
