US Set To Delay New China Tariffs... And Why This Is The Worst-Case Market Scenario

Over the weekend, when previewing the most likely outcome of the Trump-Xi talks, Goldman's political analyst Alec Phillips said that "a commitment to re-engage seems the most likely outcome. US officials, including President Trump and US Trade Representative Lighthizer, have emphasized their interest in restarting talks."

As Phillips further noted, "in the two analogous face-to-face meetings that President Trump previously held with foreign leaders—with European Commission President Juncker in July 2018 and President Xi in December 2018—he agreed to postpone tariff increases in return for an unspecified commitment to negotiate an agreement. This seems to be the most likely outcome once again."

It appears that for once Goldman was right, because as Bloomberg reported moments ago, citing people familiar with the plan, "the U.S. is willing to suspend the next round of tariffs on an additional $300 billion of Chinese imports while Beijing and Washington prepare to resume trade negotiations."

The decision, which is still under consideration, may be announced later this week after a meeting between Presidents Donald Trump and Xi Jinping at a Group of 20 summit in Osaka, Japan.

This tentative agreement was reached during a discussion of the broad outline of the Trump-Xi agenda in a Monday phone conversation between Robert Lighthizer, the U.S. trade representative, and his counterpart in Beijing, Vice Premier Liu He, which call was described by the American readout as "productive."

On the other hand, the probability of an actual breakthrough besides delaying new tariffs is virtually nil as "the U.S. won’t accept further conditions on tariffs as part of reopening negotiations and no detailed trade deal is expected from the leaders’ summit."

As a reminder, it was a critical Chinese pre-condition to resume negotiations that the US completely eliminate already implement tariffs; it now appears that that won't happen.

So what will happen once talks resume? According to the Bloomberg sources, "although each side still wants significant concessions from the other, both agreed to dial down the tit-for-tat responses and aim for an extended truce that could soothe financial markets." Even so, it was not clear if they would set a definite timetable for their tariff truce.

The immediate paradox is that the market has interpreted this as negative news with the S&P sliding to LOD, because avoiding a worst case scenario and preventing more tariffs is precisely the one thing that could stop Powell from cutting rates by 25bps or 50bps in July, in the process tightening financial conditions sharply, and causing the market - which had already priced in 100% odds of a July rate cut - to plunge.

The irony: the best outcome for Trump, who is now obsessed with all time highs in the S&P, at this junction is to force China's hand and to escalate the trade feud, which would then "force" him to go all in on China tariffs, in the process also forcing the Fed to start the easing cycle, and push stocks higher.

As to what Trump ends up doing, we'll just have to wait and see until Saturday when the G-20 summit concludes.