Uncertainty is the one word which encapsulates the prevailing theme of politics and economics in 2019. This overshadowed everything. Despite global growth being close to its long-term trend rate, trade tensions between the US and China and perceived risks posed by Brexit lingered, leading to a slowdown in global trade. Both events dominated the headlines and central banks eventually intervened. The US Federal Reserve brought forth ‘precautionary’ interest rate cuts and the European Central Bank restarted its bond buying programme, also referred to as Quantitative Easing.
With a new year approaching we look at how the fog of uncertainty around these issues is lifting and draw some conclusions about what outcomes may result.
We start with the US and China trade tensions lifting.
Trump’s Phase One Trade Deal
Chinese disregard for the intellectual property of US companies has been a long-running complaint of the US government and companies, souring the trading relationship between the countries. Escalating tariffs on goods has caused negative sentiment which has acted as an anchor on business and is weighing down both mammoth economies.
The interconnected nature of global supply chains has made matters worse. Tensions between the two countries has widened and spilled over to other economies, particularly those with a reliance on manufacturing exports such as Germany, South Korea and Japan. The effect of erecting new tariffs has been akin to throwing grit in the ‘cogs’ of the global economy.
With talks throughout the year reaching an impasse a break through now looks likely. After a series of false dawns, US and Chinese trade negotiators are poised to sign a ‘Phase One’ deal. Making this a real deal will provide these ‘cogs’ much needed lubrication. The importance of a resolution is difficult to overstate given the total value of trade between both economies, detailed in the graph below.
Graph 1: Total Value of Annual US- China Trade (Billions of $), 1998-2018
Source: Office of the United States Trade Representative, data as of Dec 2018
What can be observed above is not only the value of US-China trade (reaching $660 Billion in 2018), but also the rate at which it has increased. In twenty years, the value of trade in goods between both countries has increased by 773%, indicating the importance of this relationship for both economies. Whilst the Phase One deal does not amount to a complete cessation of hostilities, it contains significant pledges from both participants, which are outlined below.
1.Tariffs
- The US will halve tariffs to 7.5% on $120 billion of Chinese imports once the initial deal has been signed.
- Planned tariffs on a further $160 billion of Chinese imports will not be implemented.
- Roughly half of Chinese imports will remain subject to a 25% tariff levy.
2. Imports and Purchases
- China will increase the value of imports from the US by $200 billion over the next two years.
- China has committed to purchasing at least $40 billion of US agricultural products, opening up Chinese markets for US agricultural food produce.
3. Intellectual Property
- Reform of requirements applied to foreign companies wishing to operate in China.
- US firms no longer need to form joint ventures with domestic firms to do business.
- US firms are no longer compelled to grant access to their intellectual property as precondition for market access.
Because the deal is based on binding commitments, an immediate reduction in business uncertainty is likely. Furthermore, it will create breathing space for negotiators to enhance the commitments made in this deal to resolve the primary cause of the trade war; the forced transfer of US technology.
With President Trump conveying the US’ readiness to immediately continue to Phase Two of the negotiations, at the very least agreement prevents further tariff escalation and the accompanying spectre of continued uncertainty. This is an unmitigated positive.
Source: Twitter – @realDonaldTrump
Boris’ Brexit Majority
Closer to home, the decisive electoral victory of Boris Johnson’s Conservative party also swept aside uncertainty. A stable majority for up to 5 years breaks the political deadlock which has plagued the House of Commons since 2017.
With no need to satisfy the competing and contradictory aims of parliamentary factions, a clear path for passage of the Withdrawal Agreement between the UK and EU has finally emerged, after nearly three years of continuous delay and confusion.
Reflecting this positive news, Graph 2 below details the reaction of the currency markets, with the value of Sterling reaching a 19-month high against the Dollar at $1.3514 and breaching €1.20, a level not seen since before the 2016 referendum. Whilst this has moderated in recent days, the spike is emblematic of the relief associated from a reduction in uncertainty.
Graph 2: Value of GBP vs USD and Euro
Source: Bloomberg, December 2019
It is extremely likely Boris’ Withdrawal Agreement will gain Parliamentary Approval well before the January 31st deadline. In our opinion energies on both sides of the negotiating table will turn to the future trading relationship and focus upon securing a deal before the deadline of the 31st of December 2020, which is due to be enshrined in law.
This leaves a short period to negotiate a trade agreement, but it should help focus both negotiating teams and public statements from both sides have indicated a period of constructive negotiation ahead. It is in neither the UK’s nor the EU’s interests for a disorderly Brexit.
The consequences of failing to resolve Brexit have never been isolated to questions of trade. The process of governing the country has been severely impacted. Now, the Conservatives have an immense opportunity and the responsibility for improving the UK economy. The list below gives some pressing items for the government to tackle:
- to invest for growth and to strike new trade deals;
- to rebalance sectors with an emphasis on science and innovation;
- to skew investment away from the London to poorer regions with many infrastructure initiatives;
- to tackle social inequalities by investing more money and looking cross party to solve social care.
The priorities above not only reflect the circumstances and opportunities which have arisen from Brexit, but also that many Conservative voters in 2020 have rejected their previous party allegiances in favour of Boris Johnson’s Conservative party. The priorities outlined above seek to satisfy both this new base and established Conservative voters. With a clear path to a Brexit resolution established, effective and functioning government can be restored and with it, more political certainty.
Conclusions
It is important to remember even amidst 2019’s significant uncertainty global growth remained positive; according to the International Monetary Fund, the final growth figure for 2019 is projected to be 3.5%.
Key economic fundamentals on both signs of the Atlantic remain strong; consumer sentiment and wage growth remain robust and inflation remains subdued, meaning consumers and businesses have greater capacity to spend.
This underlying strength, recent reduction in uncertainty and the accommodative policy decisions taken by central banks in 2019, creates a solid foundation for continued economic growth and a renewal of optimism in 2020.
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