A US/China trade truce, Italian budget compromise and weak emerging market momentum
US President Donald Trump and President Xi Jinping of China have called a ‘truce’ in the trade spat between the two countries. The agreement was the highlight of the G20 meeting in Buenos Aires on Monday morning. The Presidents agreed a 90-day postponement of further tariff implementation, effectively delaying the US deadline for increasing tariffs on $200bn of Chinese imports from 10% to 25% from 1 January to 1 March 2019. In this time, US and Chinese negotiators will continue to work towards a permanent solution. These further negotiations are expected to start with Vice Premier Liu He’s visit to Washington on 12 December. The US stated that China has agreed to increase purchases of energy and agricultural products and President Trump also tweeted that China had agreed to lower auto tariffs. However, as with discussions with the EU in June, China has not publicised the same outcomes.
It is not obvious to us that this weekend’s meeting has seen a significant shift in the concessions that China had offered the US in May. That being the case, we wonder how much the change in the US position reflects the political timetable (post-midterms) and recent financial market pressures. We are encouraged that US-China negotiations have resumed in earnest, as we believe it means that a material escalation in protectionism has been averted in the short term. However, the path to a more permanent solution remains difficult and we continue to consider an increase in US tariffs from 10% to 25% on the current basket of $200bn worth of goods as the most likely path, but now expect the change to occur later in 2019.
Italian bond yields have fallen in the past 10 days, on the back of the Italian government’s growing willingness to compromise on its 2019 Budget. This political shift follows the release of the European Commission’s opinion on the draft budget on 21 November, which recommended that the European Union’s Economic and Financial Affairs Council (ECOFIN) open a debt-based Excessive Deficit Procedure (EDP).
Press reports signal that the government is aiming to reduce its 2019 deficit target to 2.0% of GDP (versus an initial target of 2.4% of GDP) by postponing the implementation of two key measures, the citizen’s income and pension reforms, to Spring 2019. Yet we doubt this reduction will be enough for the ECOFIN Council to decide not to launch an EDP, as the European Commission is asking for structural reforms and is focusing not only on 2019 but also on 2020. Furthermore, based on third quarter GDP data, which has been revised down to -0.1% quarter on quarter from a preliminary flat estimate, and the latest business surveys, the government’s 2019/20 growth projections look overly optimistic and pose significant challenges to fiscal targets.
The US economy is coping with mixed messages. Weaker housing activity and a softening in business investment have added to signs of retracement in key surveys. While this does warn of softer activity in the final quarter of this year we believe it is unlikely to impact our 2018 call for 2.9% growth. However, broader consumer spending has remained solid (including October’s personal spending figures) and November’s Chicago PMI reached its second highest reading since 2011 – around the top end of the range for the last 30 years.
Markets interpreted US Federal Reserve Chair Jerome Powell’s comments last week and subsequent Federal Open Market Committee minutes as dovish and the prelude to a pause in the tightening cycle. We believe the minutes spelt out a more flexible approach from the Fed as it pushes interest rates toward their neutral rate, but still consider that path likely to involve three hikes in 2019 (including a pause and an end to the cycle in 2019). A ‘data dependent’ Fed will scrutinise this Friday’s payrolls release even more closely. We also note that Friday carries some risks of a government shutdown, with the few remaining departments that have not agreed budgets this year, facing a 7 December deadline. However, on balance, we do not expect shutdown.
Emerging market growth momentum is expected to remain weak in the second half of 2018 and early into 2019. Third quarter GDP releases in various countries have begun to paint this picture, particularly in Asia where the trade war between the US and China has started to take a toll on economic. In some cases, domestic demand strength was able to fully compensate for external weakness, as in Taiwan. In other cases, such as Thailand, the compensation was only partial.
Nevertheless, in year-on-year terms, growth moderated for both, to 2.3% in Taiwan (from 3.3% in Q2) and to 3.3% in Thailand (from 4.6% in Q2). Strong commodities prices supported Malaysia’s exports, reducing the net trade drag on growth while investment momentum strengthened, which saw growth moderate slightly to 4.4% year-on-year. For India, higher commodities prices translated into stronger imports, but a weaker consumption backdrop in the third quarter remained a factor.
As a result, Indian GDP growth moderated significantly in year-on-year terms, to 7.1% from above 8% in Q2, albeit still impacted by strong base effects following the implementation of the goods and services tax in 2017. Yet, early third quarter estimates in Central European countries showed almost no deterioration in economic activity so far: growth remained robust everywhere hovering at 2.3% in the Czech Republic and 5.1% in Poland, accelerating to 4.3% in Romania (despite very negative comparison effects), and slightly decelerating but still very strong to 4.8% in Hungary.
South Africa’s third quarter GDP is to be released this week and will be closely watched given that the country is expected to start to slowly emerge from a technical recession. The government is focused on regaining its investment grade debt rating (S&P and Fitch cut their assessment to junk during former president Jacob Zuma’s term in office) and a recovery in the economic backdrop should provide some necessary support. In Latin America, Brazilian third quarter GDP accelerated to 1.3% year-on-year driven by domestic demand; we expect this momentum to gather pace into the fourth quarter of this year and into 2019, allowing Brazil to exit its recent lethargic activity.
Euro Area: EU19 PPI (Tuesday), EU19, German, French, Italian & Spanish Services PMI and Spanish Industrial Production (Wednesday), German new manufacturing orders (Thursday), EU19 Q3 GDP,and German & French Industrial Production (Friday)
US: ADP employment change, non-farm productivity, Services PMI, ISM non-manufacturing index, FED’s Powell testifies on the US economic outlook, FED release Beige Book (Wednesday), Jobless claims, Trade Balance, durable goods orders and factory orders (Thursday), Payrolls information and Michigan consumer sentiment (Friday)
UK: BoE’s Carney gives evidence on Brexit analysis and Construction PMI (Tuesday), New car registrations, services PMI and BoE publishes record of FPC meeting (Wednesday), Halifax house prices and Moody’s review of UK sovereign debt rating (Friday)
China: Caixin Services PMI (Wednesday), Foreign exchange reserves (Friday)
Market and asset types measured by the following indices: Equities = MSCI. Fixed Income = JP Morgan and BofAML.
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