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'Anything can happen' (and probably will) when Trump and Xi face off at the G20

·Associate Editor
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All eyes are on President Donald Trump and Chinese President Xi Jinping as they prepare to face off at the G20 on Saturday— a meeting that could determine the direction of the trade war.

An extended ceasefire between the two nations appears the most likely outcome of the meetings. This week, the South China Morning Post reported that the U.S. and China have agreed to a tentative truce before the meetings, so that negotiations between the two powers can continue.

A ceasefire would avert the next planned round of U.S. tariffs on $300 billion worth of Chinese goods. Yet nothing will be official until Trump and Xi get in a room together — and even that might not resolve anything.

Earlier this week, Trump said on Fox Business that he has a “Plan B” if talks go South, suggesting that tariffs would bring in “billions and billions of dollars” to America.

It underscored that the U.S. and China’s ability to bridge their differences is still very much an open question. And any deal is unlikely to undo the damage to confidence and growth that’s already wrought by the existing tariffs.

“Even if the trade war eases, the runway for a ‘swoosh’ higher in the data is likely to be at least a few months and more likely a few quarters as businesses will be looking for confirmation that the worst in the trade war is behind us before they begin to spend and hire again,” said Torsten Slok, Deutsche Bank’s chief economist, in a note to clients on Friday.

Trump’s unpredictable negotiating style means that nothing will be written in stone — and the outcome isn’t assured, analysts say.

“I think it’s more or less fair to say that when Trump sits down with a foreign leader dealing with a major dispute, anything can happen,” said Michael Fuchs, a senior fellow at the Center for American Progress. He said the most likely outcome is a ceasefire.

Banks’ Forecasts

Meanwhile, Wall Street— which has been whipsawed on expectations of a deal — is hoping for the best, but preparing for the worst. In fact, no major U.S. bank believes it is likely that a major deal will be reached at the G20.

Banking giant UBS (UBS) hedges at a 50% chance of an extended ceasefire and a 35% chance of tariff escalation. Meanwhile, the bank only sees a slim 15% chance of de-escalation after the G20.

However, markets could respond positively to a truce according to a Bank of America (BAC) research note.

“We think risk assets will react positively in the short run to a delay in the tail risk of a full-blown trade war, especially given the backdrop of increasingly accommodative global monetary policy,” BofA’s analysts said.

“In the medium term, however, the trade war will likely continue to erode business confidence, weighing on the US, China and regions caught in the crossfire, such as Asia-Pacific and Europe,” they wrote.

There’s little doubt that the existing tariffs, coupled with a global slowdown and generalized fears of an escalation, have hammered business sentiment.

That has translated into softer U.S. economic data, and forced the Federal Reserve to entertain a new rate-cutting cycle. The central bank’s reluctance to do so has courted Trump’s ire.

“The softening investment picture amid souring business sentiment is a major factor [Fed chair Jerome] Powell cited for the committee members judging that the ‘risk of less favorable outcomes has risen,” Deutsche Bank said this week.

After a weak June jobs report, markets rallied with the hopes that rate cuts were close at hand. Yet if a Trump-Xi confab ends in a surprise deal, it could swing investor expectations of a coming easing cycle.

“An unexpected deterioration or improvement in the trade area could dramatically move the needle—in either direction—for the Fed, leading us to think markets are a bit too convinced of the magnitude of future easing,” Wells Fargo said this week.

US President Donald Trump (L) shakes hands with China's President Xi Jinping during a press conference at the Great Hall of the People in Beijing on November 9, 2017.  Donald Trump urged Chinese leader Xi Jinping to work "hard" and act fast to help resolve the North Korean nuclear crisis, during their meeting in Beijing Thursday, warning that "time is quickly running out". / AFP PHOTO / Nicolas ASFOURI        (Photo credit should read NICOLAS ASFOURI/AFP/Getty Images)
US President Donald Trump (L) shakes hands with China's President Xi Jinping during a press conference at the Great Hall of the People in Beijing on November 9, 2017. NICOLAS ASFOURI/AFP/Getty Images)

Political considerations

Both leaders are dealing with political calculations as well.

U.S. farmers have been hit hard by the trade war, while a growing number of sectors sensitive to the tariffs are warning of a catastrophe if the next round of surcharges hit Chinese goods.

Meanwhile, China’s growth has slowed sharply, and prompted Beijing to deploy monetary stimulus to offset the effects.

Derek Scissors, a resident scholar at the American Enterprise Institute who also serves as an informal advisor for the Trump Administration, insisted that while trade tensions have undermined the market, “for the U.S. economy as a whole it doesn’t mean anything.”

Yet economists argue that what happens on Wall Street often sets the tone for Main Street, and right now a rising number of investors are worried about the downturn becoming a recession.

“Markets are increasingly of the view that the Fed will cut interest rates aggressively to head off the threat of recession,” ING analysts wrote this week. “Trade policy is critical to this view given the fear that intensifying tensions will hurt sentiment, put up business costs and weaken profitability.”

The strains apparent in the bilateral U.S.-China relationship means the trade acrimony is being played out on multiple fronts.

Trump recently blacklisted five Chinese tech entities, as fears increase that the trade war could turn into a broader economic conflict. And Beijing insists that no comprehensive deal will be done without the United States normalizing business relations with Huawei Technologies, the Wall Street Journal reported this week.

“If you go after literally every single import from China, it’s entirely possible that Xi Jinping gets backed into a political corner where he needs to respond in a variety of ways, and it may be responding beyond just the trade suite of issues,” said CAP’s Fuchs.

“I think there’s a potential precipice over which this trade war could go,” he added.

“For me, the real question at the end of the day is when does Trump decide that he has to give in and enough is enough and he has to end this, and does Xi Jinping accept whatever the terms are,” said Fuchs.

Calder McHugh is an Associate Editor at Yahoo Finance. Follow him on Twitter: @Calder_McHugh.

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