The US-China Phase-One trade deal was announced on Friday night, although the reduction in US tariffs on Chinese imports was less than had been suggested by an earlier WSJ report. There were sharp reversals lower in global rates, the CNH and, to a lesser extent, the AUD and NZD. Equity markets, in contrast, retained most of their earlier gains. The GBP was the star performer in currency markets after Boris Johnson won a majority in the UK general election.
After months of conflicting reports and much speculation, the US and China have finally agreed to a Phase-One trade agreement. The agreement means that US tariffs scheduled to take effect on around $150b of Chinese imports from 15th December will now be suspended. The tariff rate on $120b of Chinese imports that were hit with tariffs in September will be halved from 15% to 7.5%. Contrary to earlier reports from the WSJ, there was no change to the 25% tariff rate on the remaining $250b of Chinese imports (i.e. those goods that have had tariffs applied to them since May). The reduction in tariffs was less than the market had expected, although it still represents a much better outcome than what had been threatened in August, when Trump had said he was going to apply tariffs to all ~$500b of Chinese imports.
The actual agreement is still somewhat hazy but will see China purchase large quantities of US agricultural goods alongside commitments to end forced technology transfer and respect intellectual property, among other things. US Trade Representative Robert Lighthizer said China would purchase between $40-$50b of US agricultural goods over each of the next two years (compared to a pre-trade war pace of $24b) while Chinese Vice Min Commerce Wang Shouwen said such purchases would go up by “a notable margin”, without quoting numerical targets. China said it expected the removal of more tariffs in due course although Lighthizer cautioned that any future reduction in tariffs would be linked to the implementation of China’s current commitments and progress in future trade talks. Trump clearly wants to retain tariffs as an enforcement mechanism and leverage. Phase Two trade talks, which will cover thorny issues such as Chinese state subsidies and alleged cyber theft, will commence immediately, rather than after the Presidential election. Over the weekend Treasury Secretary Mnuchin told CNBC that Phase two could be compartmentalised into various sub-phases.
Market expectations for large-scale tariff reductions had been raised by a WSJ report on Friday morning that said the US could lower tariffs by up to half on $360b of Chinese imports. The actual reduction in tariffs (a 7.5% reduction on $120b of imports) was seen by markets as a disappointment. Global bond yields rapidly reversed their increases over the preceding 24 hours. The 10 year Treasury yield, which had risen from 1.8% to 1.95% on Friday morning on reports of a Phase-One agreement, fell all the way back to 1.82% on Friday night. Likewise, the USD/CNH exchange rate, which had fallen more than 1% to 6.9230 on Friday morning, rose back above 7.0 as the offshore renminbi weakened.
The NZD and AUD also reversed earlier gains (which were as much related to GBP strength/USD weakness after Boris Johnson won a large majority in the UK general election) on Friday night, with the two currencies remaining closely correlated to movements in the CNH. The AUD closed 0.5% lower on Friday (and almost 1% from the intraday peak) at 0.6875, making it the worst performing G10 currency. The AUD had earlier breached 0.69 for the first time in a month. The NZD ended the week at 0.6595, unchanged on the day, but down around 0.7% from the intraday peak of 0.6636 reached on Friday morning.
Equity markets managed to retain most of their gains from Thursday night, when Trump signalled an agreement on Twitter. The S&P500 was flat on Friday but up more than 1% from the levels that preceded Trump’s twitter announcement on Thursday night. The S&P500 closed the week at a new record high and is up 26.4% through 2019. Chinese equities had earlier risen by 2.5% and European indices by 0.5% to 1%.
The conclusion of the Phase-One agreement should, in time, be positive for risk appetite and global growth expectations (which were already showing signs of bottoming) and the passing of the event risk removes a key headwind overhanging the NZD. By signing up to the agreement, Trump’s revealed preference appears to be that he is prioritising the economy heading into the election next year, which should be good for risk assets. It should also reduce the chance of further central bank easing, although rate hikes in most major countries look a long way off.
The other major event on Friday was the UK election, at which Boris Johnson’s Conservative party won a larger-than-expected majority. The GBP rose as much as 2.75% on Friday morning after the release of exit polls pointing to a sizeable Conservative majority. The GBP broke above 1.35 against the USD for the first time since mid-2018 as the market breathed a sigh of relief that Labour leader Jeremy Corbyn wouldn’t have a chance to implement his socialist policy agenda. The GBP reversed around half this move over the remainder of the session (GBP closed at 1.3332) but it was still the best-performing major currency by some distance. On Brexit, Johnson is expected to reintroduce his Brexit Withdrawal Agreement bill to parliament this week, to ensure the UK leaves the EU at the end of January. The focus at that point will shift to the negotiation of a fully-fledged trade agreement, which Johnson has said needs to be completed by the end of 2020, which is an ambitious timeline according to many observers. Given Johnson’s large (80 seat) majority, the hope is that he won’t be as beholden to the Eurosceptic wing of his party and will have more flexibility to make pragmatic compromises in the negotiations ahead.
The surge in the GBP after the release of the exit polls spilled over into the EUR, the AUD and the NZD. The EUR rose above 1.12 for the first time in four months on Friday morning. But it fell back to 1.1120 in the New York morning (to be unchanged on the day) in sympathy with the weakening in the CNH after the trade agreement was revealed. Likewise, the USD traded a 0.5% range on Friday but ended up broadly flat. The USD is near 4½ month lows.
In economic data, US retail sales were weaker-than-expected on both the core and control group measures (the latter feeds into GDP). The data could have been affected by the timing of Cyber Monday, which fell in December this year, and it can be heavily revised at times. The Atlanta Fed’s GDPNow estimate stayed at a respectable 2% for Q4. Federal Reserve Vice Chair Clarida and New York Fed President Williams didn’t seem unduly concerned by the retail sales miss, with Clarida saying that “the U.S. consumer’s never been in better shape in my professional career.” On the trade deal, Clarida said it was too early to judge the impact but “any resolution of uncertainty, assuming it’s a good deal” is a positive for the economic outlook.
The NY Fed also announced it would step-up its liquidity injections over year-end, in an effort to keep year-end funding pressures suppressed. The NY Fed will offer overnight lending across New Year of up to $225bn and longer-term repo loans that cover the New Year period of up to $190b, with those operations starting next week.
NZ rates experienced a big move higher on Friday, with the 10 year swap rate moving 13bps higher to 1.77%, its highest level since July. The move in NZ rates mirrored global moves as markets reacted to Trump’s twitter announcement of a trade deal and exit polls pointed to a large Conservative majority. The front-end of the NZ curve was more sticky, with the 2 year swap rate up ‘only’ 4bps to 1.25%. The market has pared back its OCR rate cut expectations meaningfully (as of Friday’s close there were less than 10bps of cuts priced in for 2020) but it remains resistant to pricing in any chance of tightening over the next 12 months. We can expect a big reversal of these NZ rates moves today, with the 10 year Treasury yield 8bps lower than where it was trading at the time of the NZ market close and the Australian 10 year bond future around 10bps lower in yield. There wasn’t any reaction to the release of the NZ PMI on Friday, which fell slightly to 51.4, although the index remained in expansionary territory for the second month in a row.
The services equivalent to the PMI, the PSI, is released this morning, followed by the monthly dump of Chinese activity indicators. The European PMIs are the focus tonight.