G20: US-China Trade Truce Complicates Rate Outlook

G20 tries to find common ground amid trade and tariff wars.

Fearing that tariffs imposed in the US-China trade dispute, among other developments, could slow global economic growth, central banks around the world quickly shifted to a more accommodative monetary policy in the first half of this year. Now that a temporary truce has been declared in the trade war between the world’s two largest economies and a new round of tariffs has been avoided, some analysts say central bankers could reconsider the need for lower interest rates.

While stock markets rose when the trade ceasefire was reached on the sidelines of the annual summit meeting of the Group of 20 nations in Osaka, bond markets retreated. If a trade deal is reached, the Federal Reserve and other central banks could lose a major justification for cutting rates.

“Positive market reaction [to the trade truce] will be temporary,” says Kuniyuki Hirai, managing director and head of Trading in the Americas at Mitsubishi UFJ Financial Group. “The US and China turned the clock back for only a couple of weeks, as existing tariffs are still in effect.”

Market participants will soon begin to see the effects of these tariffs, Hirai predicts: “We expect the market to focus on economic data from both countries, as the imposed sanctions will come into effect sooner rather than later.”

If history is any guide, it could take 15 or 20 years to resolve outstanding trade issues between the US and China. “A handshake agreement is only the start of a long journey,” Hirai says, pointing to lessons learned from the US-Japan trade war of the 1980s and 1990s.

Likewise, “investors should remain braced for a bumpy ride toward a more conclusive deal” between the US and China, says a recent report by Mark Haefele, global chief investment officer at UBS Wealth Management, and UBS strategist Vincent Heaney. The Trump administration has been pressing China to step up intellectual property protection, eliminate forced technology transfers and secure greater access to its markets, they point out. Neither side is in a rush to make a deal and both believe they have strong cards to play, according to the UBS report.

The G20 meeting brought other positive news on global trade. The EU and Mercosur, the South American trading bloc, agreed to a trade deal after 20 years of negotiation—“the largest free trade agreement negotiated by the EU,” the report says.

But there’s plenty of room left for disruption once the US and China sit down and talk. Any trade deal would likely include a foreign exchange agreement similar to the 1985 Plaza Accord to weaken the dollar, given President Donald Trump’s recent complaints about dollar strength, Hirai argues. Trump recently criticized the president of the European Central Bank for suggesting the need for more monetary easing in the eurozone to bring inflation up to its 2% target.

“Mario Draghi just announced more stimulus could come … making it unfairly easier for them to compete against the USA,” Trump said. “They have been getting away with this for years, along with China and others.”