There has been some progress at long last.

    The US and China may be close to ending some of the tariffs they have imposed on each other’s exports. 

    China’s Ministry of Commerce has said both sides had agreed to "remove some of the additional tariffs in phases” which will “help to stabilise market expectations.”

    Questions remain over the much-discussed ‘phase one’, not least where Presidents Trump and Xi will meet to put pen to paper (earlier this month officials were still squabbling over where the signing party should be).

    More importantly, which tariffs are first to go is still undecided. According to China's Ministry of Commerce spokesman, “that will depend on the content of the phase one agreement."

    Nevertheless, capital markets initially took the comments as decidedly good news. Both Chinese and US stockmarkets climbed higher in response.

    The US-China trade war has been one of the biggest market concerns ever since Donald Trump was elected – even more so since the negative effects on businesses and consumers have started to come through.

    Negotiations between the world’s two largest economies are now more important than ever, as markets need reasons to be positive in the face of slowing global growth.

    Sure enough, the apparent thawing of trade tensions (along with some other titbits of good news) seemed to signal an improvement in market sentiment.

    False dawns?

    But we should not get ahead of ourselves.

    Erratic policy decisions and sudden turnarounds are the hallmarks of Trump’s presidency, often swinging from confrontation to reconciliation in the space of 140 Twitter characters.

    Only three months ago he seemed to support the idea of decoupling the two economies entirely.

    Chinese policymakers have also proved surprisingly stubborn or opportunistic at key moments of decision. Experience of this trade war makes us wary of false dawns.

    The two sides have found a way to talk to each other, but their ultimate aims may still be incompatible.

    Still, there are reasons to think genuine agreement could be round the corner. As we have written before, both sides have an incentive to get a deal done.

    China is in the throes of a damaging economic slowdown, while the Trump administration is no doubt worried about how tariffs are affecting the President’s voter base.

    The latest signals point to compromise from both sides. Beijing seems to have loosened its requirement that the US drop all tariffs as a precondition to any trade deal – with officials now accepting the more gradual approach to negotiations.

    The US was also reportedly considering removing the round of tariffs it imposed in September on around $112bn worth of Chinese exports.

    Crucially, China also appears willing to make the value of their currency part of a deal.

    Currency is a key talking point for Trump. He began labelling China a currency manipulator the moment he stepped into the White House, and continues to allege (somewhat incorrectly) that they have been forcing their currency lower to gain a competitive edge.

    Earlier in the year, Beijing held the value of RMB relatively strong against the dollar as a show of good faith. When discussions stalled during the summer, they seemed to let the value of the currency fall.

    Yet in recent weeks they seem to have restrengthened the RMB to 7 against the dollar, and there are suggestions that fixing the currency exchange rate at a different level could be a part of any comprehensive deal moving forward.

    The parallels with Japan

    Chinese leaders will no doubt be aware of the historical parallels of their situation.

    An East Asian country with an ageing population and burgeoning credit bubble, involved in a trade dispute with the US – and the US demanding a currency fix.

    Japan found themselves in this exact scenario in the 1980s, after which they agreed the famous Plaza Accord with President Reagan stating they would allow their currency to strengthen.

    That accord is often cited as one of the main reasons behind the Japanese asset bubble of the late 1980s, and the years of economic stagnation that followed.

    Japan’s high level of savings were not channelled outwards, at least not directly. Investor conservatism and the perception that the Yen would strengthen instead led to plunging interest rates.

    Banks, corporations and their regulators were ill-equipped for the situation, so the liquidity channelled straight into unproductive real estate investment and the property bubble ensued.

    The similarities for China are obvious and, for a government dominated by growth targets at all levels, a similar outcome is unthinkable.

    That may explain China's willingness to have an agreement in phases.

    Earlier this month, Chinese officials were said to think that a comprehensive trade deal with “this president” would be impossible – hinting they would prefer to work with Trump’s potential successor.

    China may prefer to drag it out beyond the end of next year (or sooner, depending on the impeachment proceedings) – in the hope they will have a more amenable negotiating partner.

    That may be the case, but the outcome of the US election is impossible to call at the moment and is beyond Chinese control. It wouldn't be wise to make the trade outcome a hostage to fortune.

    Beijing may prefer to have someone else on the other side of the table – if only for the sake of having a more consistent negotiating partner, but there is no guarantee that Trump’s replacement would be more willing to compromise.

    Elizabeth Warren, the current favourite for the Democratic candidacy, is known for taking a tough line on many issues, and could well outflank Trump’s hardline approach on China.

    Trump is more likely to ignore any political action that China’s administration may take in its “hemisphere of interest” (to use the phrase the US coined in the Cold War).

    Noises from Vietnam, Taiwan and Hong Kong rumble on, and there is a clear risk that China becomes unable to bear the dissent.

    The end is far from nigh for the US-China trade war. But the Trump administration will want to sign off on an effective victory for phase one, and start work on phase two of the agreement as soon as possible.

    Whatever way you look at it, recent developments are positive compared to what we heard previously.

    Given how important an issue this is for equities, we think it makes the recent upward swing in valuations justified.

    It's still uncertain whether the phase one talks will hold up. If they do, the only negative is that – barring a capitulation of one side, and the removal of all tariffs – further upside for sentiment may now be limited.

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