US-China deal will be a short-term truce

There are times, including in armed conflict, when adversaries see it in their own interests to opt for a truce and sell it to the outside world as a steppingstone to a comprehensive peace. But both sides know it will be only a prelude to renewed tensions down the road.
This could well be the best way to think of the “phase one deal” between China and the United States. Yet, it’s not how the equity markets see the situation. Instead, they are pricing the deal as simultaneously improving both the immediate and longer-term economic outlook.
After a protracted negotiation process, the American and Chinese governments finally reached agreement on a rather narrow set of issues. Pending additional information, stock markets have interpreted this as constituting a meaningful and immediate de-escalation of trade tensions, driving several indexes to record levels.
The most cited benefit is removing the short-term risk of tariff increases, a development welcomed by much of the US manufacturing sector. This has led some observers and market strategists to anticipate a halt to the contraction in global manufacturing, leading to higher business investment, the notably lagging components of global GDP growth. As desirable as this is, such a favourable medium-term outcome is unlikely to materialise for several reasons.
First, the deal doesn’t address in a decisive way long-standing grievances that the US have about certain Chinese trade practices. It’s essentially a transactional deal that exchanges higher Chinese imports of US goods for removing the threat of a December 15 increase in the level and scope of US tariffs on Chinese goods.
Second, the deal is too narrow to reverse deep and growing bipartisan support in the US for a tough stance against China, not just for economic purposes but also on grounds of national security and human rights.
Third, enforcing and verifying this deal are far from straightforward, exposing an important internal vulnerability.
Fourth, neither President Donald Trump nor President Xi Jinping seem keen to explicitly put their signatures to the agreement, leaving trade officials to sign. Finally, the leading edge of the decoupling process – technology – continues to fuel tensions which saw China threaten Germany this week over Huawei Technologies Co. We need only to look at some of the short-term political priorities in China and the US to understand why they opted for a short-term agreement that lacks sufficient substance and robustness to pivot to a durable resolution.
Amid a noisy impeachment process and the risk of a slowing economy in the run-up to next year’s election, the Trump administration has been seeking an explicit win, as short in duration as is probably intended. China’s interest lies in gaining time to accelerate internal restructuring needed to reduce sensitivity to trade disruptions. This is especially important when short-term stimulus measures are increasingly inconsistent with longer-term structural reforms.
Judging from the price moves, the fixed income and currency markets seem to understand this better than the stock market. Specifically, the first two have been much more guarded in translating short-term relief into a longer-term lifting of the uncertainties facing global growth. Policymakers, rather than believe that global economic conditions will now turn from headwind to tailwind, would be well advised to press forward with domestic pro-growth reforms during this period of relative peace.
While hoping for the best, it’s better to treat the phase one deal as only a short-term truce.
—Bloomberg