Rathbone Weekly Commentary
American stock markets kept posting new record highs last week as the US and China unveiled the details of their trade war ceasefire.
If we had to characterise this phase-one deal in one word it would be ‘inequitable’. The 96-page deal, agreed last Wednesday, makes many punchy demands of China. There appear to be many fewer sacrifices on the American side. Most prominently, all current US tariffs on Chinese goods remain in place.
Under the agreement, China must almost double its imports of American goods and services over two years. China took in $130 billion of US exports in 2017; over the next two years it must buy an extra $200 billion. Almost half of this quota is made up of manufactured goods ($78bn), with the next largest energy (liquefied gas, crude oil and coal to the tune of $52bn), followed by $38bn of extra services. Agricultural goods have the smallest increase, at $32bn, yet President Donald Trump is already using this as an electioneering platform in Texas.
The two parties agreed to enhance intellectual property protections, including greater penalties for theft (measures that China had already embarked on). From 1 April, foreign ownership laws will be relaxed in China, allowing US finance companies to take control of joint ventures with local firms (a long-standing restriction).
In return, the US will take “appropriate steps” to make American products available in China in order for the nation to fulfil its obligations. It also struck China from its list of currency manipulators, officially recognising that the country is no longer trying to artificially devalue the renminbi in a bid to get an edge on trading rivals. This is laughable. The IMF investigated the claims in July and found the renminbi was broadly where you would expect given market forces. But, hey, China does have a bad rep for messing with its currency in the early 2000s and memories tend to stick, so it plays well with the US base.
In fact, China has been trying to increase the value of its currency in recent years or, at least, keep it from falling too much. It does this by selling extraordinary amounts of its dollar foreign exchange reserves (sort of like a country’s savings account) in return for renminbi. The effect of doing this: the amount of renminbi bouncing round the world goes down and the amount of dollars goes up. All things equal, greater supply pushes the price of something downward (dollar falls) and greater scarcity makes something more valuable (renminbi rises). China has burned through almost $1 trillion of its foreign exchange reserves – a quarter of the total – since 2014.
As it goes, this deal seems precarious. And not only because of Mr Trump’s unpredictability. These quotas are extremely ambitious. Still, the simple fact that the two sides have come to terms is good news, which is why stock markets skipped higher last week. Chinese GDP is slowing yet holding up ok. US earnings have been relatively strong and American households are still happy as Larry. The worries of recession have once again been submerged in a rising market.
Source: FE Analytics, data sterling total return to 10 January 2020
Back at home, the week’s been a bit of a mixed bag.
An overwhelming Conservative majority in the House of Commons has encouraged investors and businesses, who anticipate at least five years of business-friendly policies. The stock market has stepped higher and the Rightmove house price index posted its largest ever January jump. Both of these improvements will no doubt be given yet more impetus by murmurings from the Bank of England (BoE) about a potential cut in interest rates. After CPI inflation continued its descent to 1.3%, the probability of a 25-basis-point cut to the BoE’s rate soared from 5% to more than 60%.
But that’s sort of the story right there. One of the main selling points for the UK is that economic growth is so fragile that the central bank is thinking about cutting rates. That’s not exactly top-drawer argument. Meanwhile, British retail sales posted their second consecutive month of sub-zero growth compared with a year earlier; economists had hoped they would rise by 2.6%. And the unassailably powerful government may be less business friendly than many assume. Chancellor Sajid Javid told the FT that the government would “not be a rule-taker” from the EU and that the UK would be out of the trading bloc – without a customs union – by year end.
Such a strategy will no doubt play extremely well with the voters. But not so much with the businesses that are already uncomfortable with the light-speed exit timetable. Nonalignment with EU regulations is a strong message in abstract. It sounds good, like taking control of our laws and taking a stand against bureaucracy. Yet in practice, such a strategy is a nightmare for multinational businesses whose intricate supply chains crisscross our borders. In fact, it could be even worse for smaller businesspeople who, despite having simpler operations, simply don’t have the resources to deal with added strain.
This strategy would likely lead to much higher trading costs between our island and the Continent (see chapter 2.2 Trade and Industry in our 2016 report). While tariffs tend to be the bits that attract most attention from the media and the half-curious, the biggest ‘friction’ in trade are all those rules and regs that include certifying that products are safe and legitimate (rather than toxic and made in offshore sweatshops) to labelling and biosecurity.
In the short term, the UK should benefit from greater optimism among the households whose spending drives the economy and an accommodative central bank. But in the medium to longer term, the UK is at risk of lessened trade, which could lead to higher prices and a perpetually weakened currency. Perhaps most at risk is the financial centre of the City. This is where most of the country’s most productive jobs are and it is also one of the economy’s more incorporeal sectors. There’s not much to move but information and people. And even carmakers and aeronautics firms, which have made huge physical investments here, have warned that they may be looking for the exit.
At heart, the UK hopes to regain its sense of individuality – and global power. But it should take note of a remarkably unguarded comment by Mr Trump’s chief trade negotiator about America’s preference for atomised global trade: “If you’re the biggest economy in the world, you’re far better off with bilateral agreements,” Robert Lighthizer said last week. “You’ve got more leverage. If you’re Switzerland, you’re better off working through a group and trying to get a coalition. If you’re the United States, you don’t need to.”
If China struggles to get reasonable terms with the world’s market, how will the UK fare? And what sort of terms can we secure against the EU, the second-largest market? Not all questions in this world should be answered in pounds and pence, and it may be that we are happier to be poorer in wealth and richer in intangible freedoms. But we should be honest about the trade-offs.
UK 10-Year yield @ 0.63%
US 10-Year yield @ 1.83%
Germany 10-Year yield @ -0.21%
Italy 10-Year yield @ 1.39%
Spain 10-Year yield @ 0.47%
Economic data and companies reporting for week commencing 20 January
Monday 20 January
UK: Rightmove House Prices
Trading update: Anglo Pacific, Etalon Group, Fevertree Drinks, Henry Boot, Kape Technologies, M&C Saatchi, Renewl, Warehouse REIT
Tuesday 21 January
UK: Average Weekly Earnings, Unemployment Rate, ZEW Economic Sentiment Survey, BoE’s Mark Carney Speaks at Davos
Half-year results: IG Group, Joules Group
Trading update: Dixons Carphone
Wednesday 22 January
UK: Government Finances, CBI Business Optimism
US: MBA Mortgage Applications, Chicago Fed National Activity Index, House Price Index, Existing Home Sales
Trading update: Close Brothers, Sage Group
Thursday 23 January
US: Leading Index
EU: ECB Interest Rate Decision, Consumer Confidence
Annual results: Blue Prism
Half-year results: NCC Group
Trading update: Computacenter
Friday 24 January
UK: Manufacturing and Services PMIs
US: Manufacturing and Services PMIs
EU: ECB Survey of Professional Forecasters, Manufacturing and Services PMIs
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