The US/China power struggle is far from over

Macro 5 minutes to read

Eleanor Creagh

Australian markets strategist, Saxo Bank

Summary:  Markets are in limbo as traders and investors await the much-anticipated meeting between Chinese leader, Xi Jinping and US President Donald Trump, the outcome of which could dictate the tone of trading over the Northern hemisphere summer.


Given that this could be a crucial pivot point for ongoing trade negotiations markets are likely to remain in a holding pattern until after the G20 summit. Despite the US equity markets touching all-time highs post last week’s Federal Open Market Committee meeting, small caps and transportation socks are sending a divergent signal, relative to the S&P 500 they are close to hitting lows last seen in 2009. This illustrates that beneath the market surface the degree of uncertainty about the trajectory for growth remains high and all eyes will be on the outcome of the G20 meeting.
 
Gold, on the hand is likely a different story as heightened geopolitical tensions, a pullback in the USD, collapsing yields and central bank easing continue to fashion a constructive environment for gold. Another potential mover could be the kiwi dollar with the Reserve Bank of New Zealand’s meeting tomorrow “live” for a rate cut, and potential for the RBNZ to reiterate growth concerns whilst the NZD/UD pair sits at a 2 week high.

On trade, the US administration at first positive, has continued to downplay expectations because the risk of disappointment is high heading into the planned talks. It is worth noting that Trump has somewhat boxed himself into a corner as he has said he will raise tariffs if no agreement comes out the G20 meeting. Although one wonders whether this is really an issue for Trump as he has proven in the past he is more than happy to turn on a dime. Given that the US administration has continued to add Chinese companies to the Dept. of Commerce Blacklist, including Chinese supercomputer makers, and in China anti US sentiment and nationalist propaganda has been rife.  It will be difficult for both leaders to walk away with a mutual show of strength on any material outcome unless the two leaders soften their stance considerably. 

In addition to the US blacklisting additional Chinese Tech companies that lead the development of China’s high performance computing ambitions over the weekend, the Washington Post reports the  US has found three large Chinese banks in contempt for refusing to comply with subpoenas in an investigation into North Korean sanctions violations. The three banks thought to have violated sanctions face the threat of penalties being invoked which could see them cut off from US funding. Continued pressure from the US administration on China’s key industries hardly sets the stage for friendly talks at the G20. Hence, we remain somewhat pessimistic and maintain that the best-case scenario remains an agreement to restart negotiations again. 

At any rate, it remains apparent that trade is a mere sideshow to the unfolding fight for technological and economic supremacy, and we should be prepared for a long and protracted battle between the US and China even if an agreement is reached on trade. China’s 21st century ambitions span far and wide across industries where the US is typically the dominant innovator and controller of technological advances. China’s ultimate aim is not to be on a level playing field with the US, but to outpace the US and become the global leader in high-tech manufacturing, thus threatening the US’ hegemonic status. A trade deal is not likely to hold these plans up.

China may concede the bare minimum needed to pacify the US trade hawks, but other reforms will be much harder to seek commitment.

China’s white paper on trade outlined a firm stance on protecting Chinese sovereignty and laid down Beijing’s prerequisites for reaching a trade deal. Including the US removing additional tariffs, realistic purchases of US goods and a balanced agreement. This sentiment has been persistently echoed across Chinese media in the run up to the meeting between the two leaders. It is unlikely that the US will adhere to dropping tariffs in order to strike a deal given that the US administration are already wary of China withholding their end of any bargain that is reached. After all their reputation for empty promises precedes them. Enforcement using “snapback” tariffs has been a key discussion point for the US administration, so it is likely the threat of tariffs is going to be ever present. 

If China is unable to make concessions on just that one prerequisite alone it seems that the prospect of a trade deal depends largely on Trump’s calculation of what will score points with his voters and secure his re-election. This could shift in any direction at any moment! But right now – why back down? Trump’s polling is OK and equity markets are hovering around all time highs. There is no requirement to back down yet. And a bad deal would be worse than no deal at this stage, given the onus is on Trump not to squander this opportunity to level the playing field with China. 

China meanwhile faces a more visibly slowing economy, industrial output has slowed to the weakest level since 2002 and growth in fixed asset investment is decelerating along with cooling PMIs as factories feel the pinch of the trade war. But this doesn’t mean Xi will fold, Xi will always protect China’s sovereignty and what the party view as key to China’s economic reform, something nationalistic state media have gone to great lengths to point out.

China is currently a high middle-income economy according to World Bank classifications, but it hopes to transform into a high-income country via a focus on productivity growth and high tech innovation. China has delineated its plans to become a world superpower within the next 30 years, with the aim of restoring China to a dominant position in the world order from its 19th century decline. China has far more capacity to wait out the trade war in a “long march”. This could see Trump overplay his hand because he focuses on the incoming Chinese data without the comprehension of Chinese culture and nationalism giving the ability to dig their heels in and play the long game.
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