Stocks could determine the fate of trade talks between the United States and China

  • Just a little over a week ago it looked like a trade deal between the United States and China was a done deal.
  • But talks seemed to quickly derail after President Donald Trump tweeted about increasing tariffs on Chinese imports. China has retaliated by doing the same to US imports.
  • The escalation in trade tensions has seen stocks in both the US and China fall, reflecting increased uncertainty as to whether a deal will be reached.
  • Some strategists believe the lager the falls in stocks, the more likely a trade agreement will be reached.

Just a little over a week ago it looked like positive progress towards a US-China trade deal was being made. But talks seemed to quickly derail after President Donald Trump tweeted about increasing tariffs on Chinese imports.

“The Tariffs paid to the USA have had little impact on product cost, mostly borne by China. The Trade Deal with China continues, but too slowly, as they attempt to renegotiate. No!,” Trump wrote.

Existing 10 percent tariffs on $200 billion worth of imports wereincreased to 25 percent last Friday, a move that China subsequently followed this week byincreasing existing tariffs on $60 billion of US imports. Few were expecting an escalation in trade tensions only a couple of weeks ago, but that’s exactly what’s happened.

The subsequent barrage of trade headlines and tweets have been hard to keep up with in recent days, especially as so many have delivered conflicting messages as to whether investors should fear the worst on the prospect of a trade resolution.

Stocks, both in the United States and China, have fallen since Trump’s May 5 tweet. In the US, the S&P 500 has skidded 3.8 percent. In China, the CSI 300 — comprising large cap stocks listed in Shanghai and Shenzhen — has slumped by an even larger 6.9 percent.

Wrong-footed by the sudden escalation in trade tensions, some investors have rushed for the exits, an understandable reaction given increased uncertainty over whether a lasting trade agreement will ever be reached.

Read more: The US-China trade war is back on — here are 3 reasons it won’t cool off any time soon

While that uncertainty is likely to persist for some time ahead of the G20 meeting late next month — an event where Trump and Chinese President Xi Jinping are set to meet — further declines in stocks could actually work in the favor of those who want a trade deal to be reached.

“We think the weaker the stock market performance, the more cooperative both sides will be, as what happened in 2018 is a worst-case scenario that both sides will likely avoid,” said Steven Sun and Kate Zhang, members of HSBC’s China equity strategy team in a note released last week.

“What happened last year was that the US stock market performed much better in the two quarters following the first US tariff announcement on 26 March 2018. Share prices rose 10 percent before dropping 20 percent from their September high towards year-end, triggering the intervention of ‘Plunge Protection Team’ of the US government,” they added.

“Hence, we think it’s still in both countries’ interests to avoid a similar outcome as seen in last year.”

HSBC is not alone in thinking the larger the falls in stocks, the more likely a trade deal will be, especially with the US 2020 Presidential election fast approaching on the horizon.

“We retain our view that a resolution to the US-China trade conflict will ultimately be confirmed as it is politically inexpedient for President Trump’s 2020 reelection prospects to perpetuate economic uncertainty and financial market volatility,” said Alexander Redman and Arun Sai, Global Equity Research Analysts at Credit Suisse in a note this week.

Strategists at the bank believe there’s a “solid chance” — around 70 percent — that a resolution to the latest trade moves will be reached, considering how close both sides appeared to be just a few weeks ago.

Read more: Trump just tried to explain what China will do next, and he sounds jealous

“In late April officials had been looking towards arranging a suitable date and venue for a presidential summit confirming the deal,” Redman and Sai said.

MP Capital’s Chief Economist Shane Oliver is another who believes further stock market weakness could expedite a trade agreement.

“The risks have ramped up again after the setback in the talks and the associated loss of trust on both sides so investors need to allow that the trade war could again get worse before it gets better risking further short-term weakness in share markets,” Oliver said. “In fact, sharper share market falls may be needed to remind the US and China of the need for a deal.”

Oliver thinks a trade agreement will be reached “once both sides refocus on the economic costs of slower growth, higher consumer prices and potentially rising unemployment.”

“This is particularly relevant for President Trump given his desire to get re-elected next year as rising prices at Walmart and rising unemployment will drive a backlash,” he said.

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