The US-China trade deal: too good to be true?

Sebastién Galy, Sr. Macro Strategist at Nordea Asset Management

The trade deal between China and the United States should be concluded in June and rightfully celebrated, yet it is unlikely to last as the objectives of the two countries are too divergent. Any deal will be more of a pit stop in a repeating process that will most likely last for two decades as China’s population peaks in 2025 and China’s economy becomes more vulnerable with lower potential growth.

Impact: While the China/US trade deal will be celebrated ahead of its signing, the odds are that some doubts about it falling apart in a year or two should then eventually emerge. Such risks continue to suggest holding defensive/value stocks as a hedge within a wider equity, absolute return and flexible fixed income portfolio.

  • Strategic competitors: US and China

While the US and China head towards a trade deal, it is unlikely to last for long as neither party agrees on their place within the global architecture. Both see themselves as dominant with China seeming to replicate its 16th century mercantile model. China has a limited window to ramp-up and maintain a sustainable position as its population ages and it approaches the status of a slower growing advanced economy. Globally, China has a secondary Russian partner and an array of allies within emerging markets including via its belt road project. As happened during the cold war, dominated economies will play both sides for the maximum advantage. In some cases, courtesy of defaults, China has acquired strategic assets abroad. From a military point of view, each will strive to maintain a first strike advantage for a nuclear conflict or a conventional one (e.g. the feared dark horse of Huawei), yet any conflict would be very limited in scope and time given the severe feedback loop (sanctions) and limited fiscal and currency space (e.g. Crimea). That leaves most of the conflict and cooperation to be decided by a series of temporary accords. For example, the US apparently agreed that China would ramp up some imports into 2025. The Europeans are following up with their own effort. Economic imperative should generally outweigh other motives.

  • When do blocks cooperate?

Major countries tend to cooperate when the alternative is far worse, when their business cycles are intertwined and when they want to create a super-group (e.g. the European Union). They cooperate because they assume that others will continue to do so over time as the gains far outweigh other strategies. If the gains are seen as a temporary reset, the odds of deviating are very strong, which is partly the case for China.

China is building its domestic economy with its own search engines and tech giants much as Japan and South Korea did before it. The difference is that it has the scale of a market to be able to get away with it. The Europeans did the same before by subsidizing the emergence of Airbus (and others). It is unlikely that China will veer for long from a policy of national champions.

China has a key vulnerability relative to the United States amid a large and growing trade imbalance. Negotiations should shrink China’s large trade surplus. In theory, the larger the surplus the stronger the currency, so this would suggest a shrinking of the CNY against the USD, which is free floating. Gains of exchange suggest that the trade balance will stay somewhat one sided. The conclusion is we are faced with a much lighter version of the cold war in which gains of exchange and the search for power are intertwined

  • What pulls blocks apart?

Geopolitical blocks are pulled apart by either internal or external dysfunctionality. Excessive competitive pressure can lead down the road to a severe backlash against trade. Some Emerging Market economies have been known to lose focus of inflation when facing a large slowdown. Competition for a common scarce resource, such as energy, can also have deleterious impacts as can new technologies (e.g. fracking).

In conclusion, the US and China are likely to go through a series of agreements and necessity will tend to pull back partners to the table particularly as potential growth weakens more in China.

About Nordea Asset Management

Nordea Asset Management (NAM, AuM 204.8bn EUR*), is part of the Nordea Group, the largest financial services group in Northern Europe (AuM 282.6bn EUR*). NAM offers European and global investors’ exposure to a broad set of investment funds. We serve a wide range of clients and distributors which include banks, asset managers, independent financial advisors and insurance companies.

Nordea Asset Management has a presence in Cologne, Copenhagen, Frankfurt, Helsinki, London, Luxembourg, Madrid, Milan, New York, Oslo, Paris, Santiago de Chile, Singapore, Stockholm, Vienna and Zurich. Nordea’s local presence goes hand in hand with the objective of being accessible and offering the best service to clients.

Nordea’s success is based on a sustainable and unique multi-boutique approach that combines the expertise of specialised internal boutiques with exclusive external competences allowing us to deliver alpha in a stable way for the benefit of our clients. NAM solutions cover all asset classes from fixed income and equity to multi asset solutions, and manage local and European as well as US, global and emerging market products.

*Source: Nordea Investment Funds, S.A., 31.12.2018

 

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches, subsidiaries and representative offices. This document is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. Consequently, the information contained herein will be superseded in its entirety by such Offering Memorandum or contractual arrangement in its final form. Any investment decision should therefore only be based on the final legal documentation, without limitation and if applicable, Offering Memorandum, contractual arrangement, any relevant prospectus and the latest key investor information document (where applicable) relating to the investment. The appropriateness of an investment or strategy will depend on an investor’s full circumstances and objectives. Nordea Investment Management recommends that investors independently evaluate particular investments and strategies as well as encourages investors to seek the advice of independent financial advisors when deemed relevant by the investor. Any products, securities, instruments or strategies discussed in this document may not be suitable for all investors. This document contains information which has been taken from a number of sources. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information and investors may use further sources to form a well-informed investment decision. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment. Prospective investors or counterparties should also fully understand the potential investment and ascertain that they have made an independent assessment of the appropriateness of such potential investment, based solely on their own intentions and ambitions. Investments in derivative and foreign exchange related transactions may be subject to significant fluctuations which may affect the value of an investment. Investments in Emerging Markets involve a higher element of risk. The value of the investment can greatly fluctuate and cannot be ensured. Investments in equity and debt instruments issued by banks could bear the risk of being subject to the bail-in mechanism (meaning that equity and debt instruments could be written down in order to ensure that most unsecured creditors of an institution bear appropriate losses) as foreseen in EU Directive 2014/59/EU. Nordea Asset Management has decided to bear the cost for research, i.e. such cost is covered by existing fee arrangements (Management-/Administration-Fee). Published and created by the Legal Entities adherent to Nordea Asset Management. The Legal Entities are licensed and supervised by the Financial Supervisory Authority in Sweden and Luxembourg respectively. The Legal Entities’ branches, subsidiaries and representative offices are licensed as well as regulated by their local financial supervisory authority in their respective country of domiciliation. Source (unless otherwise stated): Nordea Investment Funds, S.A. Unless otherwise stated, all views expressed are those of the Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and representative offices. This document may not be reproduced or circulated without prior permission. Reference to companies or other investments mentioned within this document should not be construed as a recommendation to the investor to buy or sell the same but is included for the purpose of illustration. The level of tax benefits and liabilities will depend on individual circumstances and may be subject to change in the future. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and/or representative offices.

 

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