Morning Commentary: Remember the Trade War?

A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.

Remember the Trade War? Share this story: Andrew Kositkun Foreign Exchange Head Trader

With the U.S. elections and COVID-19 developments dominating headlines, U.S.-China trade has taken a backseat. Three years into a trade war between the two largest economies, how has bilateral trade fared so far, and what can be expected from the Biden administration? Following the U.S. and China’s tit-for-tat escalation that started in early 2018, bilateral trade fell sharply in 2019. China’s imports from the U.S. fell 21.3% year-over-year with exports to the U.S. falling 12.9% year-over-year. In hindsight, we now know that China diverted most of its trade away from the U.S. to the rest of the world as nearly 75% of Chinese exports to the U.S. are subject to additional tariffs. Trade between the U.S. and China eventually bottomed and rebounded in 2020 due to the Phase 1 trade deal and the COVID-19 pandemic. The Phase 1 deal helped to boost China’s imports from the U.S. with record-high agricultural product orders. Nevertheless, the rebound has been far short of what Phase 1 purchase targets would imply. This isn’t unexpected, as the import targets were very optimistic even before COVID-19 hit. With a little over a month to go, China’s imports from the U.S. should exceed 2019 levels, but will fall short of pre-trade war levels. Regarding COVID-19, the pandemic helped Chinese exports rebound quickly due to strong demand for medical supplies and stay-at-home products such as computers and appliances. In total, the U.S.’s 2019 trade deficit with China has shrunk back down to 2016 levels, but the deficit was at a record-high in 2018-19. Overall trade numbers show that targeted trade tariffs have had little impact on the overall trade balance as tariffs simply shifted the imbalance to other countries. Further, estimates from the Congressional Budget Office expect tariffs to reduce real GDP by roughly 0.5% even when accounting for tariff revenue gains that came at the expense of U.S. firms and consumers. Looking forward, President-elect Joe Biden’s criticism of economic damage of tariffs suggests that he will remove them, but this is unlikely to happen quickly. Being tough on China is an issue that receives bipartisan support, and removing tariffs can be interpreted as being “soft” on China. Additionally, existing tariffs can be used as a tool to negotiate on other issues such as intellectual property rights, government subsidies, cyber security and human rights. At best, tariffs will likely be phased out gradually, starting with consumer products. This said, there is scope for the Biden administration to shape how the U.S. approaches China. The incoming administration should adopt a less confrontational approach that is more predictable and centers on reforming, rather than sidelining, international organizations. To be clear, China should still face pressure on the trade front, despite de-escalation to some extent, if the U.S. is better able to coordinate with its allies to pressure China together. Given this, expect the new administration’s near-term focus to be COVID-19 and domestic issues over international ones. HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT: Markets received another positive shot in the arm with AstraZeneca announcing that its vaccine candidate was 70% effective against COVID-19 for a two-dose regime. This effectiveness rose to 90% if you used half a dose followed by one full dose later. Even if you assume a lower efficacy (70%) than other treatments, the AstraZeneca vaccine has advantages, as it can be kept at refrigerator temperatures versus the Pfizer and Moderna candidates that require freezing for storage and transport. This should make it easier to distribute beyond developed markets.     News reports indicated that President-elect Joe Biden is pushing House Democrats to reduce the size of their fiscal aid package demands to move negotiations forward. In essence, the Biden team appears to be willing to compromise on the size of the deal in exchange for expediency, as emergency unemployment benefits are set to expire at year-end. Additionally, it appears that Biden may use executive orders to extend the moratorium on evictions and foreclosures and deferring student loans.    U.S. PMI measures came better than expected with manufacturing, services and composite series printing 56.7, 57.7 and 57.9, respectively. Consensus was for a manufacturing print of 53.0 and a services print of 55.0 making this a significant beat. The U.S. is close to issuing a list of 89 Chinese companies that would be unable to access American tech exports due to their military ties. Brexit headlines remain positive with EU officials saying that a deal is 95% agreed. U.K. Prime Minister Boris Johnson is expected to make a “significant intervention” in talks this week with EC President Ursula von der Leyen in an effort to break the deadlock. The deadline remains a moving target, but sources indicate both sides are working toward wrapping things up by Dec. 1. The pound has been trading higher on Brexit optimism, but this rise has made the risk/reward trade-off less attractive due to the potential for last-minute brinkmanship against a currency that has significantly priced in a deal. Eurozone PMI came in mixed with manufacturing beating expectations, but services disappointing as the composite score moves into contractionary territory. This month’s print reveals the damage that COVID-19 containment measures have had on services. Nevertheless, relative to the first lockdown, services sentiment is still much stronger due to less stringent containment and relatively less uncertainty. On a country level, German and UK PMI beat expectations, while France’s print disappointing. It should be noted that, while German and UK services PMI beat expectations, they both remain in contractionary territory, reflecting lockdown measures which hit services harder than manufacturing.

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