US-China trade talks are about to start — a cut-down deal could lift some tariffs by year-end

Chinese President Xi Jinping (R) and US President Donald Trump at the Great Hall of the People in Beijing on November 9, 2017.

Nicholas Asfouri | AFP | Getty Images

China and the U.S. resume trade talks Thursday in a prickly atmosphere, and strategists say the best outcome could be a postponement of the next round of tariffs but not much else.

Strategists say it's also more likely now that the Trump administration will agree to a trimmed-down trade deal that could lift some tariffs before year-end but pushes off some of the thornier issues, such as intellectual property and technology transfers, for future talks.

The negotiations are the first high-level talks in two months and come as other issues have been bubbling up in the increasingly tense relations between the U.S. and China. China is retaliating against the National Basketball Association by cutting back on its preseason tour and canceling broadcasts in China, after a Houston Rockets executive tweeted support for Hong Kong protesters.

The U.S. this week also blacklisted 28 Chinese companies, due to alleged human rights violations against Muslim minorities in China's far-western region of Xinjiang. The list includes some of China's next-generation companies involved in artificial intelligence and machine thinking. The U.S. had previously blacklisted Chinese telecom company Huawei for claims of cyber espionage.

Beijing's expectations for progress in this week's talks were reduced, following that move by the Commerce Department, according to a Reuters report quoting Chinese officials briefed on the talks. Stocks pared some gains after the Reuters story appeared late in the trading session Wednesday.

"If you're looking for good news, they didn't cancel the trip," said Tom Block, Fundstrat Washington policy strategist.

But later Wednesday, stock futures plummeted after the South China Morning Post reported that the U.S. and China made no progress in deputy level talks this week, and that high level talks will now be cut to one day Thursday instead of two days. 

Partial deal?

Chinese negotiators are reportedly open to negotiating a partial trade deal with the U.S., but it is unlikely to be reached this week, according to Bloomberg News, which was quoting an unnamed official with direct knowledge of the talks. According to the Financial Times, Chinese officials are offering to buy more U.S. agricultural goods, in a show of goodwill, raising soybean purchases to 30 million tons, from 20 million.

"I think the probability of a deal in the next week is low, but I think some time in November, early December we do get a smaller deal that extends buying power for Huawei and some concessions from China in terms of purchasing soybeans and pork, some very small things," said Ethan Harris, Bank of America Merrill Lynch head of global economics.

Strategists say the impeachment proceedings against the president may make Chinese negotiators believe President Donald Trump needs a victory at home, but they say the election could be an even bigger catalyst for both the White House and China. Sen. Elizabeth Warren, a surging Democratic candidate who now leads in some polls, is an unknown and if elected she may be even tougher on China on human rights and other issues than Trump.

But there is also a view that China may want to wait out the election to see who will be seated across the negotiating table. As for Trump, it is widely expected he will seek a deal before the election.

"The president's approval rating is highly correlated to the probability of a China deal coming," said Dan Clifton, head of policy research at Strategas.

Clifton said a deal may be reached soon that will not be as comprehensive as the White House has been looking for. The slimmed-down deal would likely be presented as a first step.

"What's changed is the tariffs that were ratcheted up in May have started to really inflict pain on both sides," said Clifton.

Tariff delay?

The strategist said it's likely the tariffs scheduled for Oct. 15 would be delayed. If not stopped, the tariffs on industrial goods would rise to 30% from 25%. "That means the supply chain will accelerate out [of China] faster," said Clifton. "That's what they've come here for — to get that delayed."

There are also tariffs that have been put on hold until December. Those are the first tariffs that would directly hit consumer goods and were announced by Trump as negotiators last met.

Trump has said he does not want a partial deal with China, but Clifton said there's the possibility that a sweetener could be thrown in to a trimmed-down deal that would make it more appealing. "What you've seen is Larry Kudlow discussing in the last couple of days is if they agree to open up foreign ownership so U.S. companies don't have to be 51% owned by a Chinese company. That would go a long way towards protection of intellectual property rights," he said.

Kudlow, White House economic adviser, is not part of the talks that are set to take place in Washington between Chinese Vice Premier Liu He, U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin on Thursday and Friday.

Distrust

Strategists say as the relationship between the two countries has become more strained, it's less likely a comprehensive deal can be agreed on. Both sides have become more distrustful of the other, and the environment ahead of the talks is rife with negative headlines and badgering.

Ian Bremmer, Eurasia Group president, said his Washington sources are not optimistic for a breakthrough and, on the Chinese side, President Xi Jinping no longer trusts Trump. "He expended a fair amount of political capital trying to work this out with Trump, specifically at the bilateral talks at G-20," said Bremmer, adding Xi may see the president as too erratic. "Trump is not going to be trusted by him."

Harris said Trump's handling of Mexico also damaged his credibility. After agreeing to a new trade deal with Mexico and Canada, Trump threatened in June to put tariffs on Mexican goods over immigration issues, unrelated to trade.

"The idea that a trade deal doesn't mean no more tariffs was quite a powerful message to China," he said.

"I think the trust between the two sides has deteriorated dramatically here," said Harris.

He said he expects a "skinny" deal. "The question is how skinny is it?" he said. "The problem is neither side wants to give up anything easily, and they don't trust each other. The trust is a big deal, but it isn't just the trust, the gap has grown because the tariffs have gotten bigger and bigger over time. Rolling them back has become a bigger deal."

Harris said he doesn't expect the impeachment process to have an impact on the talks, unless Trump is removed from office.

"China's got very limited goals in the short run. They want to keep Huawei's access to U.S. imports so the company can compete in global markets. That's important to China. Beyond that, I don't think they have much they're looking for. ... They're very reluctant to do a comprehensive deal. They don't know if any deal will stick. They look at the experience of the summer: They were close to a deal, and it didn't happen," he said.

The U.S. has granted temporary exemptions for Huawei suppliers.

Block said the U.S. move to blacklist Chinese companies this week could hamper even limited progress. "Before this announcement I think people thought, at a minimum, they could keep on talking and have a temporary standstill like they've done in the past. ... That's now in doubt," he said. Block said he does expect a more comprehensive deal, just because the two economies are so important to each other, but it will not be any time soon.

Harris said a big concern is how the administration treats Huawei and whether it extends the exemptions on U.S. imports.

"That would be a really big move, taking a bellwether company in China and basically killing their global business. It's a very big escalation because unlike a tariff, it's a ban," said Harris.

If the U.S. does not extend exemptions, it would be a significant event, raising questions about which companies would be next. "That would be breaking new significant ground. That's an event that could be market moving. This is more like two kids in a sandbox throwing stuff at each other," he said.

Strategists say tensions around the trade talks have intensified because of disagreement on other issues and China does not want to see interference or criticism for what it sees as its internal affairs.

"I think the whole negotiations have become much more complex because of Trump saying China should investigate Biden," Harris said. "It becomes more complicated because of the Hong Kong escalation. Things were already getting more difficult over the summer with the escalation of the trade war. ... The negotiations have gotten very messy."

"It's a lot harder to do a real deal than it was," he said. "The expectations for me have been dramatically reduced for what's a doable deal."

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