US-China trade war optimism to continue – but for how long?

November 08 2019

Peiqian LiuChina Economist. Ranked Top 10 China forecasters by Bloomberg.

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After the stress of August, it appears as though sentiment towards the US-China trade war has entered a new phase. Peiqian Liu, China Economist, outlines why we are witnessing this surge in optimism from markets and investors.

It is hard to believe that it has already been eighteen months since US-China trade talks first began. So at this important milestone, we thought there was no better time to look over the trade war as a whole using the NatWest Markets China Stress Index. And we’ve noticed there is an interesting emerging trend – we’re calling it the Trade War Sentiment Cycle.

Introducing the Trade War Sentiment Cycle

Since the trade war began, we’ve seen two and half rounds of escalation and de-escalation market sentiment dynamics. Comprising five main stages, the cycle looks like this:

  1. US is tough on China
  2. Talks in progress, optimism builds
  3. Optimism peaks thanks to a short-term truce
  4. Market scepticism or hopefulness towards the prospect of a lasting deal
  5. Talks breakdown again, and we’re back to the US being tough on China once more (i.e. back to stage 1)

What’s behind the recent optimism?

In June, we reported that market stress towards China had hit new highs, after rising sharply at the end of June. The picture today is very different. As you can see in the chart below, the China Stress Index has been steadily falling since the beginning of September.

Chart 1: China Stress Index (May –November 2019)

Source: NatWest Markets

A combination of factors

We think that this change in sentiment is a combination of more progress on trade deals being disclosed and some goodwill moves (albeit small steps) from both the US and China. In particular, the recent delay on the 15 October tariffs, as well as China’s increasing purchase of US agricultural products, has been key in fuelling an uptick in positivity.

Why? Well, put simply, it suggests that both teams were working hard to achieve a Phase I deal. Added to this is the fact that officials are aiming for the Phase I deal text to be finalised and signed by President Trump and President Xi Jinping at the upcoming APEC (Asia-Pacific Economic Cooperation) Summit in Chile on 16-17 November. Any step towards achieving something concrete is typically a warm welcome to markets and investors alike.

US-China trade war optimism to continue – but for how long?

We think the near-term optimism is set to continue, at least for the next month or so as we’re expecting a “Signing Ceremony” to take place as planned in  November. And as for the actual underlying disputes between the US and China? They’re likely to remain unresolved.

In fact, market scepticism could rear its head quickly  once the details of the Phase I deal is disclosed if it falls short of market expectations on structural issues, for example. If so, the market will then once again face more uncertainties and possible future escalations, and we will enter another stage in the Trade War Sentiment Cycle

When will the trade talk cycle break?

At this stage, we have not yet seen any strong evidence to suggest that the trade talk cycle will break any time soon. As long as the existing tariffs are not rolled back – or indeed, taken off the table completely – we remain cautiously pessimistic on the outlook, with the view that US-China trade talks will still have the risks of breakdown and stays within our summarised sentiment cycle.

Chart 2: Expected trajectory for the China Stress Index

Source: NatWest Markets

Regional focus: China

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