The much anticipated G20 summit in Osaka, Japan is coming soon on this Friday and Saturday (28-29 June). This is a pivotal event for financial markets as the Chinese President Xi Jinpaing and U.S President Donald Trump is about to have a bilateral meeting during the event, who will negotiate and try to solve the economic and trade disputes between the two countries. Meanwhile, market base case remains that the two parties are unlikely to reach a formal detailed agreement at the meeting, but there will be no further trade war escalation and US holds off on additional China tariffs for at least a fixed number of days and weeks. The US and China will commit to re-engage more negotiation after the G20 summit, and eventually the two leading economies will reach some sort of a trade deal by late 2019 or early 2020.
If happens, the base case scenario should be neutral to slightly positive to the stock markets, depends on how long the “breath” both parties agree to have and how committed in wordings that they will have more negotiation in future. The base case scenario should help reviving investors’ confidence, as well as minimizing the risk of an immediate recession as the US Fed is expected to take proactive rate cuts from July.
In contrast, if the G20 summit fails to prevent an escalation of the trade war, no matter it is an additional 10% or 25% tariff on all remaining $300bn imports from China, equities are expected to be adversely affected, especially for the Chinese exporters and companies that have high US sales linkages such as those in the Tech Hardware sector. According to UBS, an additional 25% tariffs on $270bn Chinese imports will drag on China’s GDP growth by another >80bps over a 12-month period, with Q3 and Q4 this year likely hit the hardest. Moreover, the impact of restrictions on Huawei will likely to subtract another >40bps of China’s growth over the next few quarters. We expect other impacts and potential policy reactions from China and US will be as follows:
i) China exports may eventually fall by 10% in 2019F and 8% in 2020F, in USD terms, while imports may also down by 8% and 7% during the same period;
ii) China may face a current account deficit of approximately 0.3% of GDP in 2019F and 0.8% of GDP in 2020F
iii) PBOC may cut RRR by 150bps this year and another 100bps next year; the benchmark interest rates may also cut by 50bps in 2019F.
iv) Chinese government’s fiscal easing may increase such as more tax cut, higher infrastructure investment, more unemployment support, the speed up of financial reforms and SOE reforms, or even some relaxation of property measures.
v) USDCNY may depreciate to 7.3 by end-2019 and 7.4 in 2020.
vi) US’s PCE core inflation may increase to 2.5% by end-2019, but slowing to 1.9% in 2020 as tariff impacts gradually fade.
vii) US may cut the Fed fund rate by 75bps in 2019F and another 50bps in 2020F
viii) In aggregate, China’s real GDP growth may slow to 5.8% in 2019F and 5.5% in 2020F, while US real GDP growth may slow to 2.2% and 1.8% during the same period.
In a nutshell, market generally expects US-Sino trade dispute to improve after the G20. The current stock market valuation seems do not price in the risk of negotiations breakdown and more tariff hike. Therefore, in the worst-case scenario, the stock market may once again fall to the bottom of last year. Investors should diversify their portfolios amid the current uncertainty.