Why One Bank Thinks That Much More Market Pain Will Be Needed To Close Any Trade Deal

Futures are sharply lower again after the weekend failed to provide any substantive evidence that the "constructive" tone suggested by both Steven Mnuchin and Liu He on Friday was present, and in fact, soundbites from both president Trump and Chinese media indicated that the latest trade war escalation may last well into 2020 without a resolution, with China potentially waiting to see if Joe Biden is be elected president, helping to resolve the trade war.

Yet while we now know how and why the trade talks unraveled so fast thanks to a detailed expose by the WSJ, which reports that "U.S. and Chinese governments both sent signals ahead of their trade talks in Washington last week that a pact was so near they would discuss the logistics of a signing ceremony" but "in a matter of days, the dynamic shifted so markedly that the Chinese deliberated whether to even show up after President Trump ordered a last-minute increase in tariffs on Chinese imports because the U.S. viewed China as reneging on previous commitments", the question remains what this means for markets.

While there have been various "hot takes" on what the latest escalation means for risk assets, with many suggesting that a "no deal" outcome potentially triggering a plunge in the S&P below 2,600 and forcing the Fed to cut rates, one of the better assessments of the future state of capital markets as a function of the ongoing trade war, comes from Bank of America's chief economist Ethan Harris, who in "Once more to the brink" writes that his "long-standing view on the trade war is that the Trump Administration wants deals and will compromise, but only after it extracts the maximum concessions." To Harris, this is a pattern of big demands and moderate concessions that we have seen play out repeatedly. And this case is no different: both the US and China want a deal, "but motivating the inevitable compromise requires some combination of market, economic and political pain."

Specifically, we have seen this framework play out in the past year in two ways:

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