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Trade negotiations between the U.S. and China got the attention of investors this week. Uncertainty about the economic impact and the likely duration of the conflict has caused nervous sales and high volatility.
The commercial rivalry between the U.S. and China will take a long time to define itself; however, in the short term economic circumstances force the parties to seek agreements and establish new rules of the game.
Conceptually we have defined four probable broad scenarios based on the intensity of actions against trade and the time needed to reach an agreement:
As an initial scenario, we have the current situation, where U.S. China and China maintain mutual tariffs on imports, negotiations will follow their current course and could reach an agreement in 2019.
The expected framework agreement would establish reforms in China gradually and the U.S. it would reduce its rates according to the progress of the changes.
In the second and third possible scenarios, tariffs, trade restrictions, and sanctions between the parties were increased. The critical difference between the new situations would be that the more extended period necessary to reach an agreement.
In the second scenario, in our opinion, the preferred one by the U.S, the drastic increase in tariff and penalties manages to accelerate the negotiations and reach an agreement at the end of 2019 or the beginning of 2020.
In contrast in the third case, in our opinion the preferred one by China, the penalties are maintained, but a significant delay of the negotiations is achieved, reaching up to 2020 and 2021.
The additional duration causes the economic impact to be higher than the second case, especially for the U.S. We do not expect parties to reach this scenario, but the possibility of it can be an element of negotiation in itself.
Finally, the fourth case of confrontation would imply a new state of instability beyond 2021 without an established trade agreement, a sort of miscalculation of the parts where there is no mutual space for a deal.
For this case, the economic implications are very high and involve the rest of the world's economies. Rationally, we do not believe that any of the countries wish to reach this situation voluntarily.
We are considering that these trade negotiations are the beginning of a stage of continuous confrontations investors need to get used.
The level of commercial, industrial and operational integration between the U.S. and China is very high, and the complexity of supply chains and business relationships have taken decades to develop in the previous globalization paradigm.
We can infer that there will be constant changes to the commercial agreements between countries and that incremental demands between the two countries may continue for the foreseeable future.
The complexity of some changes required by the United States on China would imply a profound political, institutional and cultural reforms for them.
Implementing these changes by China will require political will, time and a process to verify compliance of these changes by the U.S.
However, we consider that China today wants to implement many of those changes as part of its process of opening and internationalization, but would find it indispensable, that the agreements must be politically and media-friendly locally.
Given this context, the implications for a rational investor in financial markets are diverse and complex. From being ready to take advantage of market volatility in your favor, to review the allocations in each asset class to seek to maximize benefits with the lowest risk desired.
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Have a productive week!