Morning Commentary: A Big Beautiful Monster

Foreign Exchange - Morning Commentary
A Big Beautiful Monster
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
After countless twists and turns, the Chinese trade delegation has arrived in Washington DC this week for the formal signing of the US-China Phase 1 trade deal that is scheduled for 8:30 PT today.   While President Trump has described this deal as a “big, beautiful monster,” there still remains some doubts around the robustness of the deal.  At just 86 pages, the Phase 1 deal appears to contain less substance than normal trade deals.  

Reports out during yesterday’s trading session indicated that tariffs would remain in place until after the US elections in November despite the signing of this deal.  No sooner than 10 months after the signing of the agreement, the US will review progress and potentially consider additional cuts on tariffs affecting $360bn of imports from China.

This period of review, which isn’t expected to be specified in the deal text, is designed to allow the US administration time to verify China’s adherence to the agreement, which will ultimately determine the extent of tariff reductions.  Additionally, it appears that the details around China’s commitments on additional agricultural purchases will be included in a confidential annex.  However, a 50% reduction in the 15% tariff on about $120bn in Chinese goods announced last December is still set to go through.  Notably, the deal will, for the first time, punish China if it fails to deliver on its commitments regarding intellectual property, currency and the trade balance. 

As the less optimistic details of the deal emerged yesterday, the markets switched to a bit of a risk off mode, but all in all, it was relatively mild.  This muted reaction is likely due to market expectations that tariff reductions will be linked to China’s performance and relief that there is a step down agreement that has de-escalated trade tensions between the two nations. 

For today, attention will turn to the details of the agreement which are still largely unknown.  Over the longer run, it bears reminding that the most significant issues at the heart of China’s model of state capitalism still remain unresolved.  This means that while reduced, tension between the two countries are still far from resolved.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • Speaking of unresolved tensions, news reports suggest that the US administration is making moves to block more sales to Huawei, China’s leading telecom company. 
  • US PPI data rose 0.1% versus expectations for a 0.2% increase.  Weakness in the reading came from a flat service sector.  The Empire State manufacturing index came in at 4.8, beating expectations of a 3.6 print.  This beat came despite risks from the Boeing 737 MAX production halt. 
  • UK MoM CPI missed as it came in flat against expectations for a 0.2% increase.  PPI data also missed as it also printed flat against expectations for a 0.1% MoM increase.  Markets are becoming increasingly focused on the possibility of a BoE rate cut with BoE member Michael Saunders pushing for a policy response to avoid a “low inflation trap.”
  • German GDP rose 0.6%, meeting expectations.  Additionally, the budget surplus as a percentage of GDP came in at 1.5%, beating expectations for a 1.2% print.  This highlights a key issue for the Eurozone as countries with fiscal space are not using it for fiscal stimulus, further prolonging the slowdown.
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