January is typically not a month when much thaws. However, the signing of a Phase One trade deal between U.S. and China, in our opinion, represents an important step forward in taking a good bit of the chill out of the cold relationship these two economic powers have endured for almost two years now. With more than $500 billion of U.S.-imposed tariffs hanging in the balance prior to the agreement’s implementation on January 15, the fact that an apparent detente now seems at hand can be viewed as a favorable incremental event, both economically and psychologically.
More than any other factor in the market over the past year, progress toward an agreement and aversion of U.S.-imposed tariffs, in whole or part, have played major roles not just in periodic market volatility but also the perceived profile for economic growth in the U.S. and globally. This agreement, signed by Presidents Trump and Xi Jinping of China, has now rolled back a meaningful portion of the $530 billion in tariffs previously enacted or to be imposed.
Specifically, $160 billion in U.S.-imposed tariffs, originally scheduled to go into effect on December 15, have now been entirely taken off the table. Approximately $120 billion originally set forth this past September have been reduced from a rate of 15% to 7.5%, and the original tranche of $250 billion implemented last summer at 25% remains unchanged. China has also agreed to agricultural purchases from the U.S. of approximately $40 billion, an increase from the pre-dispute levels of about $24 billion.
We believe investors should focus on a few key takeaways from this agreement as signs of the first official progress between U.S. and China since trade relations took a decidedly negative turn last spring.
These takeaways are:
- The Phase One deal, while certainly not eliminating the overall U.S.-China trade risk, could well represent a directional turning point as the worst may now be over between the two nations. This would be quite a favorable development for investor psychology.
- While many would have preferred more, if not all, of the U.S. tariffs rolled off, the movement in this agreement could be enough to encourage U.S. companies to increase capital spending and investment closer to pre-trade dispute levels, which could prove meaningful to overall U.S. economic growth.
- Investors should watch for the prospect of a Phase Two agreement later this year, though timing is uncertain and a second deal may not be seen until late 2020. Should such a second agreement include further tariff reductions, it would likely be well received by the markets.
While we view this official agreement as a welcomed development, it's important to recognize more drama pertaining to this ongoing soap opera may still await. If we have learned anything about this trade dispute and its associated tariffs, it’s that small changes in direction can have real impacts on economic sentiment and the markets. We're not out of the woods yet, though there is now a path.
All considered, we believe the Phase One agreement should be viewed optimistically. As we stated in our 2020 Market Outlook, Where We Stand, we believe the overall environment for the equity and credit markets appear favorable in the year ahead based on 2% or better economic growth, benign inflation, a quiet year at the Federal Reserve, rising earnings growth, reasonable valuations, and solid credit fundamentals. The Phase One trade agreement incrementally enhances this environment and adds to these potential catalysts.
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