A new round of high-level talks and some potential giveback on tariffs by China was a bright spot in the U.S.-China trade war, but strategists say the peace could be fleeting and the situation could get worse before it gets better.
President Donald Trump said in a tweet Tuesday that things are going well, with "Very productive conversations." He also said he expects some important announcements.
This is the first sign of progress on trade since Trump met with China President after the G-20 summit meeting in Buenos Aires earlier this month.
"There has to be structural reforms, and the Chinese are indicating they're willing to make those structural reforms, which means they're willing to make a deal," said Dan Clifton, head of policy research at Strategas。
Stocks got a lift early Tuesday on the prospect that talks would be productive, but the move was fleeting, and it's clear that the stock market is sensitive to developments related to trade progress.
China's Vice Premier Liu He reportedly spoke with Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer. In Buenos Aires, Trump and Xi agreed to hold off on new tariffs and agreed to talk for 90 days.
About half the recent stock market sell off is because of the trade conflict, said Ethan Harris, head of global economic research at Bank of America Merrill Lynch. " The trade war is starting to show some cost to the U.S. Whats' missing so far is because tariffs aren't really that big they haven't really begun to hit the U.S. consumer."
Economists have said the uncertainty of the 90-day period could result in some businesses holding off spending, until they see whether there's a deal by March 1, or if not, a wave of new tariffs.
Strategists do expect to ultimately see a positive outcome, whether it' s in three months or six months, because a victory on trade would be important to both sides. The talks were followed by reports Tuesday that China would make some purchases of U.S. soy beans and would roll back tariffs to an original 15 percent from 40 percent on autos imported from the U.S.
A tense week
The discussions followed a tense week between the two countries after the arrest in Canada of Meng Wanzhou, the chief financial officer of Chinese telecom giant Huawei and daughter of the founder. The U.S. sought the arrest on allegations that Wanzhou was circumventing sanctions against Iran, and the U.S. has had a long running concern about Huawei and cyber spying.
"The trade talks are extraordinarily complex," said Clifton. "While we talk about tariffs, subsidies, soy beans, those are the headlines, but there is a significant discussion happening at the agency level with the Chinese on cyber security, artificial intelligence, intellectual property. Those are going to be tougher nuts to crack but those conversations are in place."
"It is a positive the sides are talking, but this is far from the initial plan to send Liu He with a team of 30 Chinese negotiators to DC this week. The next two weeks seem unlikely for DC talks given the Central Economic Work Conference next week and the big Reform and Opening meeting. Given these high profile upcoming Chinese domestic events, a lack of trade reform announcements would likely increase the likelihood for March 1 tariffs," notes Chris Krueger, policy strategist at Cowen.
Krueger said the auto tariff reductions and agriculture purchases by China are positives but not having face-to-face meetings in December was a negative," Krueger said in a note.
Harris said he expects the talks to succeed ultimately and the U.S. should avoid the next round of tariffs, though if they do go into affect it would be for a very limited time.
"Our baseline forecast is by March 1, they have converged enough towards a deal that the markets start to feel better about what's happening. It may take a little longer to get a deal, but at least you'll be moving in the right direction. I think the progress on this is going to be very slow," said Harris. Harris said the next round of tariffs, where the U.S. could target all Chinese imports would slow China's growth to about 6 percent. Currently, he expects Chinese growth to pick up in the second half of next year.
Many U.S. economists have factored a full blown trade war into their outlook for next year, and if there is no resolution to the trade issues, growth is expected to slow to below 2 percent in the second half.