Proposed US-China trade and Brexit deals have spurred investor excitement – and once again, it’s premature

Investors can’t help but get excited hearing that deals resolving Brexit and the US-China trade war are on the cards But their optimism fails to account for the frail foundations both deals rest on, and that neither is the first of its kind to fail

Nicholas Spiro

Published: 9:00pm, 17 Oct 2019

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Hope springs eternal, especially in financial markets where the “fear of missing out” – known in the investment community by the acronym “Fomo” – on a rally can be a powerful driver of sentiment. Over the past several days, Fomo has been very much in evidence.

Since October 10, the British pound has surged more than 5 per cent against the US dollar, to its highest level since mid-May, and has not been this volatile since the days following Britain’s vote in June 2016 to leave the European Union, according to data from Bloomberg.

Mounting expectations that Britain and the European Union will strike a deal at a two-day summit beginning on Thursday, allowing Britain to exit the bloc with a negotiated settlement in place to smooth the transition to a new trading arrangement, have fuelled a sharp recovery in sterling, which is living up to its reputation as a “political currency”.

Signs of progress in US-China trade negotiations have provided an additional fillip to markets. A limited deal, tentatively reached last Friday – which would see Washington hold off on a further rise in tariffs planned for this week in exchange for minor concessions from Beijing – has reinforced investors’ belief that President Donald Trump is under more pressure to agree a truce with China to improve his chances of re-election.

The cautious optimism over trade has triggered a sell-off in gloomy government debt markets, with the yield on the benchmark 10-year US Treasury bond up 20 basis points since last Tuesday. However, the flip side of Fomo is complacency.

Apart from the obvious fact that investors have had their hopes dashed many times before – the previous trade truce only lasted from early December to the beginning of May, while the first Brexit deal was rejected three times by the British Parliament – the damage wrought by the trade war and Brexit is already done.

Last week, Kristalina Georgieva, the new head of the International Monetary Fund, put things in perspective. She noted that, two years ago, nearly 75 per cent of the world economy was growing. Now, a staggering 90 per cent is decelerating. The global economy is currently in a “synchronised slowdown”, with growth in global trade having “come to a near standstill”.

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While it stands to reason that a marked decrease in geopolitical risk ought to stabilise markets and improve the prospects for growth, given that it was geopolitical tensions that caused the downturn in the first place, the current trade and Brexit deals that are being thrashed out are by no means game-changers.

Not only do the agreements fail to address the causes of the political and economic problems that gave rise to Brexit and the trade war, their beneficial impact on sentiment is diluted by the persistent uncertainties bedevilling the global economy.

IMF managing director Kristalina Georgieva recently highlighted that 90 per cent of the world is seeing slowing growth, with global trade growth at a “near standstill”. Photo: AP

As JPMorgan rightly noted in a report published last Friday, the “peace dividend” for markets from any trade and Brexit deal is very limited.

First, in the case of the trade dispute, the so-called “phase one” agreement leaves the most intractable issues in the conflict, notably forced technology transfer and industrial subsidies, firmly on the negotiating table. What is more, it keeps in place the existing tariffs on Chinese goods, with no indication of when, or whether, they will be lowered or scrapped.

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Just as worryingly, there was no joint statement or text. The respective pledges were instead sealed with a handshake between Trump and Chinese Vice-Premier Liu He. Considering the president’s unpredictability, and given the equally strong anti-China sentiment within the opposition Democratic Party, the deal is, frankly speaking, not worth the paper it is written on.

Contenders for the Democratic nomination debate on July 31 in Detroit. Several Democratic candidates have identified China as the US’ greatest geopolitical threat. Photo: AP

As for Brexit, more than three years of debilitating uncertainty, in which Britain has become ungovernable and the economy has slowed to the point where it is likely to have only narrowly averted a recession in the third quarter, has left the country in an awful state.

Even if Prime Minister Boris Johnson is able to strike a deal with the EU this week – a big if, given the significant misgivings about the accord on the part of his hard-line allies in Parliament – the fact remains that his proposed agreement will prove even more damaging to growth than the deal favoured by his hapless predecessor, Theresa May.

Investors who have suddenly turned bullish on the pound would do well to reflect on the findings of the think tank The UK in a Changing Europe. Johnson’s insistence that Britain operate its own customs regime (and therefore diverge more sharply from EU law) will “involve significant non-tariff barriers on trade”, resulting in a more significant drop in income per head than under continued EU membership, the think tank warns.

A phoney trade truce and a “harder” Brexit hardly qualify as a peace dividend.

Nicholas Spiro is a partner at Lauressa Advisory

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