Dow Ignores Pricing in US-China ‘Phase 2’ Trade Deal Fallout

• Reports suggest that a phase two deal between the U.S. and China could fall apart, causing Dow Jones rally to fade.
• China’s economy is declining and U.S. is still at risk of recession, leaving both countries in favor of a deal.
• European markets seem to be pricing in difficulties around the talks, showing confidence from investors towards a successful phase two deal.

Despite reports about the potential fall out of a phase two deal with China, pre-markets data indicate the Dow Jones is set to open at 27,943, up 94 points from Friday’s close.

Behind the strong momentum of the Dow Jones is likely the expectations of investors that the trade talks will continue to see progress in the short term.

Trade deal confidence boosts markets; but is it misguided?

The U.S. and China have long struggled on key issues such as industrial policy reforms and the protection of intellectual property.

Unresolved discussions around the sensitive areas of the deal have eventually delayed the signing of a phase one deal, which is yet to be finalized.

Still, markets in the U.S. and Europe seem to have priced in the difficulties surrounding a phase two agreement, as shown by the recent rally of the Dow Jones and the DAX.

The Dow Jones Industrial Average (DJIA) is up by nearly 1,000 in the past 30 days. | Source: Yahoo Finance

According to Bloomberg, the economy of China has been recording slowing growth throughout 2019. In August, China saw its worst single month industrial output growth since 2002.

Bank of America Merrill Lynch’s chief Greater China economist Helen Qiao said:

In terms of policy room, we still think there’s quite a lot for both the Ministry of Finance and the PBOC, but now it’s a matter of whether they want to use it. What I worry about is that policy makers are hesitating at the moment because of the potential implications on the long term impact, so they’re really fallen behind the curve.

With China’s central bank cautious in introducing more stimuli to control the long term growth of the nation, in the short term, China is expected to see slowing growth ahead.

The declining economy of China will affect how the government proceeds with the completion of a phase one deal, and a phase two deal that is set to follow.

Dow Jones unaffected, priced in difficulties

Since U.S. President Donald Trump announced an agreement on a phase one deal on October 12, both China and the U.S. have said that the signing of the first deal would swiftly lead to the second.

A Trump administration official told Reuters:

As soon as we finish phase one we’re going to start negotiating phase two. As far as timing around when a phase two deal could be completed, that’s not something I can speculate on.

Although the trade talks have lagged for nearly a month, the Dow Jones and the global equities market show that investors are confident both countries have sufficient incentives to achieve a deal by the year’s end.

Without a trade deal, the GDP of China is speculated to fall by at least 6%. Janet Yellen, the former Federal Reserve chair, said that the U.S. could fall into recession with or without a deal, making the agreement important for both countries.

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