US/China trade tensions ease; focus moves to Fed policy outlook and EU leadership
US President Donald Trump and Chinese President Xi Jinping held meetings on the fringes of the G20 meeting in Osaka this weekend.
As a result, President Trump announced that trade negotiations were “back on track”, that the US would impose no new tariffs on Chinese goods (“at least for the time being”) and that negotiations would continue on the basis of “equality and respect”. President Trump stated that China would purchase a “tremendous amount of agricultural products”. The US also eased pressure on Huawei, with the Commerce Department scheduling some relaxation in restrictions. Although President Trump announced that this was not a “general amnesty”, he conceded that a possible removal of Huawei from the entity list was possible as part of a broader trade package. This caused some hostile reactions from Congress and suggests that the administration’s current stance on China tech has at least some transactional aspect, rather than being purely strategic.
The announcements were broadly in line with our expectations. The weekend avoided an escalation of trade tensions that we believed threatened to tip the US economy into recession. Yet beyond that, absolute progress was limited. The situation is reminiscent of trade tensions after the previous G20 meeting at the end of last year. There is nothing to preclude a further worsening in relations between the US and China again, as has been seen over the last six months. Moreover, the US continues with hawkish trade rhetoric towards other regions, including the European Union (EU). Ongoing trade uncertainty looks set to continue to weigh on business sentiment. We believe this additional headwind is one that the US Federal Reserve is likely to have to address.
Following the US trade truce, focus will return to the Federal Reserve (Fed)’s policy outlook.
With the worst-case trade scenario averted, we doubt that the Fed will want to ease monetary policy by the 100 basis points priced in by markets over the coming year. It is thus likely to begin to try to wean markets from such expectations. However, it will be wary about how quickly it does this, for fear of a sharp tightening in financial conditions that could further weigh on the economic outlook. We forecast two rate cuts (to 1.75-2.00%) this year.
The market expects the Fed to cut in July but a post-trade truce rise in risk assets and a rebound in this week’s payrolls could see the Fed string out the first cut – we currently expect it in September. However, with manufacturing indices weakening across the board, the incentive for an ‘insurance’ easing is growing and the Fed will be wary of a sharp equity correction over the summer. We will watch the ISM manufacturing index this afternoon, wary of a sharper drop than the current consensus of 51.2 from 52.1, and the payrolls report on Friday - where we see some chance of a stronger outcome than the consensus for 160,000 jobs to have been added in June. Fed Chair Jerome Powell speaks to Congress on 11 July - this will be the Fed’s best opportunity to shift market expectations from a July cut. If it does not change expectations before then, we will adjust our forecasts to expect the first Fed cut in July rather than September.
Last week remained mixed in terms of data, with the European Commission’s economic sentiment survey dropping to a 34-month low, while the flash estimate of June core inflation surprised to the upside at 1.1% year-on-year.
Details at the national levels suggest that part of the bounce in core inflation was due to volatile components and base effects, and thus we remain of the view that core inflation pressure will only very gradually build up over the horizon (1.1% in 2019 and 1.2% in 2020).
This week attention will focus on final Purchasing Manufacturers’ Index (PMI) data. Manufacturing indices released this morning were depressed, and Spain in particular surprised to the downside, falling below 50 to its lowest level in six years. We will also get German manufacturing orders that will help to gauge the health of the German industrial sector in the second quarter - so far, signals have been bleak. Finally, ahead of the first inaugural session of the new European Parliament (2-4 July), European leaders continue to struggle with the allocation of top EU jobs. At last night’s EU summit, the appointment of the Dutch Socialist Frans Timmermans to the head of the European Commission was blocked by the Visegrad group (Hungary, Poland, Czech Republic, Slovakia) and the centre-right European People’s Party. But negotiations continue today, and his candidacy is still being discussed - leaving hopes for an agreement by the end of the day.
US: ADP employment change, trade balance, services PMI, factory orders and ISM non-manufacturing index (Wednesday), non-farm payrolls, unemployment average earnings and the Fed’s Monetary Policy Report (Friday)
Euro Area: EU19 Producer Price Index (Tuesday), EU19, German, French, Italian and Spanish services PMI (Wednesday), EU19 retail sales (Thursday), German new manufacturing orders and Spanish industrial production (Friday)
UK: Construction PMI (Tuesday), services PMI (Wednesday), new car registrations (Thursday), Halifax house prices (Friday)
China: Caixin Services PMI (Wednesday)
Japan: Manufacturing PMI (Tuesday)
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