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Markets went from misery to happiness last week on news of progress on two of the biggest political sticking points in developed markets right now.
China and the US moved closer on trade, and Britain and the EU moved closer on Brexit.
So what happened? And how long before it all unravels?
A ceasefire in the trade war
On the Chinese trade war front, here’s what happened: as Arthur Kroeber of Gavekal puts it, the US and China have agreed “a cease-fire”. The US had planned to increase tariffs on Chinese goods even further on 15 October. Now it won’t do that. And the Chinese have resumed buying goods from US farmers.
That’s it. In immediate practical terms, very little has changed, for all that US president Donald Trump proclaimed this as “phase one” of a trade deal. However, the important change for markets is the shift in political tone.
The effect of the trade dispute is now being felt in both countries. The US has an election in November 2020. If the inversion of the yield curve is as reliable an indicator as it has been over the past 50 years or so, then the US has a high chance of being in recession by then.
Needless to say, that wouldn’t help Trump’s re-election chances. Regardless of voter tribalism – and the fact that the economic cycle is a hard thing to subvert – recessions are not good news for incumbent politicians. They usually get the blame, and they usually get kicked out as a result. Given the Federal Reserve’s apparent reluctance to cut interest rates drastically, Trump needs to do what he can to avoid exacerbating things.
Meanwhile, on the Chinese side, there’s the trouble in Hong Kong, and the more general fact that the economy is slowing down anyway, regardless of US tariffs.
Neither side wants to be seen to back down. But neither side needs this particular set of headaches.
So, as Kroeber says, what we will probably get next is some sort of narrow deal when Trump and Chinese president Xi Jinping next see each other at the G20 meeting in November in Riyadh.
There’s an element of both sides standing down in public, but continuing to wage a battle over all the areas that are really causing the problems in the first place – the concerns over technological supremacy, for example.
What does that all mean? Arguably it means that relations between China and the US have hit a new, lower plateau. It means plenty of room for future areas of conflict. But it does also suggest that the tariff wars specifically might be over, which in turn reduces the risk that China pulls off a massive devaluation imminently, which reduces the threat of a global deflation shock.
Brexit descends into the tunnel
As for Brexit: at the start of last week, it looked like there was no chance of a deal. By the end of the week, UK prime minister Boris Johnson and Irish taoiseach Leo Varadkar were both talking positively and everyone started talking about talks entering a “tunnel” (no, I have no idea where that metaphor came from either).
The pound rocketed on hopes of a deal – last week was a great week for sterling. Of course, this morning, we’re seeing the EU say that we’re not there yet, and the pound is easing off again.
Now, there are familiar echoes here of the usual EU approach to negotiations. We embark on a rollercoaster loop of euphoria, exasperation, and despair – a bit like playing the middle section of The Hero’s Journey on repeat, if it was applied to a particularly boring film – and then a rabbit is yanked out of the hat at the last moment, and the day is “saved”.
So we all think we know how this is going to pan out. But I’m not so sure that this is what happens this time.
We are stuck in the same place as we were with Theresa May’s deal. Any deal that the EU can accept probably can’t get through Parliament. (To be honest, given the conflicting motivations governing all the different parties at this point, I’m not sure that there is any deal at all that could get through Parliament.) So “no deal” certainly isn’t off the table.
For a long-term investor, I don’t think any of this should matter, by the way. The UK looks cheap right now and I suspect that from here investors will do well, regardless of the precise nature of Brexit.
However, the outcome I would really like to see taken off the table (from an investment point of view), is the one that leads to a Jeremy Corbyn government. That probably won’t be clear until the next general election, which in turn, probably won’t be clear until we have a better idea of what’s happening with Brexit.
Anyway – this is just another reminder to stick to your investment plan, and don’t worry too much about the short-term twists and turns here. There’ll be a lot more highs and lows on the front pages over the coming week, and most of them will be out of date within a few hours of publication.
The swings and roundabouts in the pound matter to no one but short term traders – and you shouldn’t be getting involved in that unless you’re looking for a fast way to lose lots of cash.
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