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Trading Trump's wild card

Macro 6 minutes to read

Summary:  Global equities have lost over $1 trillion in value following President Trump's tariff threats against China last weekend, with markets now scrambling to price the likelihood of a meaningful trade deal between the world's two largest economies.

President Trump's new tariff threats came as markets had been lulled into a false sense of security, supported by dovish central banks, a vacuum of information on the ongoing trade negotiations and better than expected US corporate earnings. 

The latest posturing has put markets and investors on tenterhooks and global equities have lost over $1 trillion in value as sentiment ping-pongs between optimism that a deal is finalised and despair that talks are off. These moves were exacerbated by President Trump’s itchy trigger (Twitter) finger. Speaking at a political rally in Florida, the President lashed out at China saying "they broke the deal".
Trump tweets
First, a fact check: The tariffs are paid by US importers of tariffed Chinese goods, not by China or Chinese consumers/companies. Importers in the US then either pass the increased costs onto US consumers, lower profit margins, or both.

So is Trump’s outburst mere bravado straight out of “The Art of the Deal” playbook, aimed at securing final concessions from China. Remember, in the lead up to the final USMCA agreement, Trump was threatening to drop Canada and proceed with a bilateral US-Mexico deal. Or is something more serious afoot and are we about to spiral into another round of tit-for-tat tariffs? 

At this stage it is hard to gauge with confidence, but I am inclined to think the latter. Nevertheless, even if the latest developments turn out to be pure posturing this is a great reminder for investors not to be complacent and to maintain prudent risk management. A damning report from Reuters states that China is backtracking on all aspects of the draft agreement, jeopardising the product of months of negotiations. (

Per the linked Reuters update: "The diplomatic cable from Beijing arrived in Washington late on Friday night, with systematic edits to a nearly 150-page draft trade agreement that would blow up months of negotiations between the world’s two largest economies, according to three US government sources and three private sector sources briefed on the talks.

'China reneged on a dozen things, if not more ... The talks were so bad that the real surprise is that it took Trump until Sunday to blow up,' the source said."

These developments have altered expectations of this week’s negotiations, unwinding optimism that a final deal was imminent, as most market participants were assuming was a done deal and now the market could be under-pricing the probability of a breakdown in China-US trade talks. 

Liu He and the Chinese trade delegation will have just 12 hours from their arrival on Thursday to pacify President Trump before the tariff increase deadline at 12.01 a.m. Friday. Time is running out, and the risk of higher tariffs is too close for comfort. There is a good chance that President Trump's vow to increase tariffs on $200 billion of Chinese goods from 10% to 25% will go ahead Friday and that the trade negotiations stall for some period.

If the US follows through on its threat, the outcome will be binary, and following an initial knee-jerk reaction markets will have to reprice the expectation of a trade deal out several months, allowing for a prolonged period of uncertainty and plenty of bumps along the way before the deal is struck. We will also have to contend with the retaliatory response from China, as Beijing has made it clear that it would retaliate with "necessary countermeasures" if the US raises tariffs on Chinese products. 

It is likely that Trump's strategy to negotiate harder has been emboldened as the S&P 500 hovers around all-time highs, reducing the incentive for a swift conciliation. A common assumption is that Trump needs a win as the November 2020 vote bears down on the administration, but with the US/China relationship now becoming a bi-partisan issue and the trade negotiation sitting in a global spotlight, the onus is on Trump not to squander this opportunity and to push hard against China. This would mean allowing the trade hawks to descend and not letting China buy its way out of reforms by, for example, simply shopping for soybeans.

In fact, one of the president’s senior campaign officials argues there is perhaps more political capital to be gained from a “no-deal” scenario. Trump’s campaign appears confident that in the current political landscape, elections are won by promising to fight, not by parsing the fine print.

“The fight is more important than the resolution,” the senior campaign official told me. “So, yes, we want good policy; we want to get a good trade deal with China. But politically, I’d argue it’s almost better if we don’t.”

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China’s stance could also be firmer than many are expecting. Chinese authorities seem comfortable that the economy has stabilised, as evidenced by the latest Politburo meeting which did not focus on economic stabilisation as it did in February, following stronger than expected March economic data.

Despite tensions ratcheting higher and the increased chance of another round of tit-for-tat tariffs, the base case is that a deal will be reached eventually. This means that after a cooling-off period following tariff hikes, negotiations would likely drag on for a much longer period than market participants might have expected. The conclusion of the trade deal could be several months away, allowing for a prolonged period of uncertainty and a bumpier path than previously anticipated.

But the dispute is about more than just trade, and the events of this week should alert investors to the fact that even if we get a trade deal, the US/China relationship will still be difficult with ongoing disputes aplenty – another reason to avoid complacency. This is a long-running economic conflict and the battle for tech dominance and hegemony will continue. China will concede the bare minimum needed to pacify the US trade hawks, but other reforms will be much harder to seek commitment.

Generally, some of the reforms are in China’s best interest and reforms it needs to make anyway; China needs tighter rules surrounding IP protection as this fits its own ambition of becoming a technology leader within the Made in China 2025 plan, but whether this happens on the US terms remains to be seen. As such, the tariff threat may remain ever present as the US enforcement process is likely to be very specific in a bid to ensure China upholds its end of the deal. 

The awakening to the true gravity of this economic conflict and the ratcheting higher of trade tensions this week comes as markets have been lulled into a false sense of security, with all quiet on the volatility front

Current short positioning in VIX futures is at a record high as traders take advantage of accommodative central banker’s dovish coos suppressing volatility. And yes, short positioning is outpacing last February’s so-called “volmageddon”.

This leaves markets vulnerable to the risk of a downside correction should VIX start spiking higher.

As per yesterday’s update, the view remains that until we see a more robust macro environment and confirmation of a self-sustaining re-acceleration in economic growth, we are moving into capital preservation mode.

Risks still remain at large, and the Trump wild card is a good excuse to take profit in sectors that have run hard since December lows, thus raising cash to deploy on a correction.  

Given the recent market melt-up despite mixed economic data, one could be forgiven for wondering whether there is any point to analysing the business cycle when it seems to be all about the Fed and benevolent central banks' dovish pivots. As cynical as it sounds, sovereign bond yields have been falling and will only head lower in a market correction. The Fed is no longer on autopilot – far from it, it's in reverse and ready to rev up should the conditions present. And while it pains me to say, as central banks continue to wax dovish, market corrections will likely be bought. But this doesn’t mean they won’t be volatile, unpredictable and difficult to trade.

On that note, Saxo Chief Economist Steen Jakobsen's latest note makes great reading.


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