December 18, 2019 / 11:10 AM / By Fitch Ratings / Header Image Credit: nytimes
A signed and mutually honored 'Phase One' US-China trade deal would lessen near-term tariff risk for US Corporates and ease trade tensions, at least temporarily, says Fitch Ratings. However, the 'Phase One' deal alone is not likely to eliminate trade-related uncertainty or restore business confidence, given potentially prolonged 'Phase Two' negotiations on structural issues. The US-China trade relationship is a major watch item for US corporate credit in 2020, given the size of the Chinese market, intricate global supply chains and implications for world growth.
Renewed escalation of US-China tensions remains a significant risk. Trade tensions and tit-for-tat retaliatory actions have caused uncertainty for US companies, resulting in reduced business confidence, a pullback in investments and in some cases lower profitability. The Organization for Economic Co-operation and Development's (OECD) business confidence index has been below 100 for five consecutive months, reflecting pessimism toward future business performance. A focus on long-term risk mitigation strategies including supply chain adjustments, increased localized production, and end-market diversification to manage ongoing trade uncertainty will likely continue.
Official statements suggest the effective US tariff rate on imports from China could fall to about 16% under the plan, compared with earlier plans where the rate would rise to about 25%. This is due in part to the US agreeing to forego a 15% tariff on an additional $156 billion of Chinese consumer goods scheduled to take effect on December 15.
China also cancelled retaliatory tariffs due to take effect on December 15, according to news reports. As part of the trade deal, China committed to importing US goods and services over the next two years in a total amount exceeding China's import level in 2017 by at least $200 billion, according to the office of the US Trade Representative. The agency indicates changes to China's policies on intellectual property (IP) and technology transfer, historical sticking points in trade negotiations, and an arrangement to resolve disputes are also included in the 'Phase One' deal.
Reduced tariff rates might improve US relative price competitiveness but China's domestic demand trends may complicate efforts to meaningfully increase imports. A sharp acceleration in China's imports of US products seems unlikely, unless diverted from other sources, given Fitch's assumptions of mild Chinese renminbi depreciation and a slight moderation of Chinese economic growth. Even so, China's protein needs have risen due to the effects of the African Swine Flu virus on Chinese pork production and herd size.
Increased agricultural purchases by China could help support a material earnings improvement across the agricultural sector. An easing of trade tensions would also be an important development for the industrial sector, given aircraft, engines, equipment and parts top the list of US products exported to China, according to the US Census Bureau. Trade-related concerns, including tariffs and disrupted supply chains, are dampening economic activity and corporate investment, contributing to slower sales growth among US diversified industrials and capital goods companies. China is an important market for Ford and GM, and several US auto suppliers, with the trade dispute being an indirect factor leading to lower Chinese auto sales.
A 'Phase One' deal may only provide limited benefit for US technology companies, given the emphasis on structural longer-term considerations around fair market access and IP protection. Some technology companies took steps, including greater distribution from foreign manufacturing facilities and shifting orders to rivals, to mitigate the effects of tariffs over the past two years.