The Phase-One US-China Trade Agreement: Cease-Fire, Not Peace Treaty

The US and China formally signed a phase-one trade deal Wednesday after several months of negotiations. We see the deal as a near-term positive for markets—but it also leaves the thorniest issues between the two countries unresolved.

Calm…With Room for More Tension

The deal signals a cooldown period in the ongoing spat, but it also leaves many possible avenues open for strains to resurface down the road. And many of the previously imposed tariffs remain in place even after the phase-one agreement. The bottom line: US-China trade is less free today than it was a few years ago, and the phase-one deal doesn’t change that reality.

Financial markets aren’t fretting over the details of the deal. They’ve been more focused on the risk of further escalation than the macroeconomic impact of the measures already put into place. So, even though this agreement doesn’t touch most tariffs, the market’s confidence that new tariffs are unlikely means something. Of course, equity markets have leapt up by more than 10% since the deal was in the homestretch, so the good news is likely already priced in.

An Economic Boost to the US, Though Not a Game Changer

The most significant part of the deal in the near term is China’s intention to buy $200 billion more in US goods over the next two years.

If we assume that those purchases go through, the deal would likely boost US gross domestic product by roughly a quarter percentage point from today’s. That helps, but it’s not a game changer, and it probably falls short of offsetting the existing trade war damage. The $200 billion figure deserves a little skepticism: there’s a good chance US exports to China rise but exports to other countries fall, limiting the boost to the US economy.

Of course, the cease-fire could be enough to improve US business confidence and spur corporate America to invest more in domestic production as they anticipate a ramp-up in exports to China, which would make this deal much more meaningful. We’ll be keeping a close eye on indicators of business sentiment, because a rebound in capex would be very good news indeed for the US economy.

Plenty of Friction Points Remain

Over the long term, we think the details of this deal make it clear that the US-China relationship still has plenty of sharp edges. As with past negotiations (Mexico, most notably), the US administration has shown a willingness to threaten tariffs even after finalizing a deal. The enforcement mechanism agreed to this week is largely subjective, so there’s leeway for either side to accuse the other of falling short on its promises.

To sum it up, this week’s trade deal should alleviate concern about a near-term flare-up in the trade war while also reducing uncertainty more broadly—both are significant positives. But the long-term relationship between the US and China will remain contentious, and we fully expect to see renewed tensions pop up in the years ahead. Politics will largely determine when things heat up, and it shouldn’t be lost on anyone that the US election season will feature plenty of unpredictable politics.

In other words, this week’s trade deal is a temporary cease-fire—not a permanent peace treaty.

Authors
Eric Winograd
Senior Economist—Fixed Income

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

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