China and the United States stepped back from the brink of a full-blown tariff war on Saturday at the Group of 20 (G20) summit of major economies in Osaka.
After an impasse of about two months, President Donald Trump and President Xi Jinping agreed to resume trade talks and postpone levying additional tariffs.
In the short-term, the truce is a relief and global stock markets have rallied.
Both sides were playing for high stakes. The US president had threatened to slap new levies on roughly $300 billion of additional Chinese goods in July, extending existing tariffs to cover almost all Chinese imports into the United States.
In addition, the potential partial easing of US restrictions on exports to Chinese telecom equipment maker Huawei Technologies represents slightly more of a de-escalation than pundits had expected, although the details of a US climb-down remain unclear.
However, it is unlikely that the truce will hold. Hardliners in each camp are just too far apart to come to a resolution soon.
For one, there is a lack of an agreed mechanism for dispute settlement and they disagree vehemently over issues at the centre of US-China discussions, like technology leadership, intellectual property protection, market access, or government subsidies.
China could still thwart US companies’ access to China market under the guise of “unreliable entities”.
“It is slightly more likely that the US will impose tariffs on additional imports from China. We assume these tariffs would be applied at a 10% rate if they were imposed,” said economists at investment bank Goldman Sachs in a note to clients.
As the trade war rumbles on, China will have to continue with its balancing act of managing conflicting policy goals.
On the one hand, it sees the need for stimulus to offset slowing global growth and mitigate the impact of existing tariffs. The tariffs implemented to date will shave about a 0.2 percentage point off China’s growth this year through direct trade channels, said Michael Taylor at credit ratings agency Moody's Investors Service.
On the other hand, Beijing is still mindful of its medium-term goal of reducing leverage and improving the efficiency of private sector capital allocation.
Stimulus is likely to win out in the near term.
“We expect Chinese policy settings to be kept fairly loose given the lack of any immediate tariff relief and the upcoming 70th anniversary of the PRC. In particular, we would expect the USD/CNY exchange rate to remain below 7.00 in the very near term as long as productive negotiations are ongoing,” Goldman Sachs added.
Amid continuing trade war uncertainty, the markets’ rally is not sustainable.