Monday Musings: January 21, 2020

Jan 21, 2020

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Public Trust Credit Team
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The U.S. and China signed the "Phase One" trade deal

China appeared to make the majority of the concessions in the trade deal whereas the U.S. did not agree to anything outside of tariff reductions. The key points of the trade deal are:
  • China will increase imports from the U.S. by $200 billion above 2017 levels over two years; this includes a $32 billion increase in U.S. agricultural products. After two years, exports are to continue growing at the new levels.
  • China will improve trade secret and intellectual property protections for U.S. companies and provide a legal avenue for companies to process disputes after the burden of proof has been met.
  • China will commit to not pressuring companies into forced technology transfer and will make all administrative and licensing requirements transparent.
  • China will commit to the use of its overseas parent assets to fulfill applicable asset requirements for qualified subsidiaries of U.S. financial institutions.
  • By April 1, 2020, China will remove the foreign equity cap for financial services firms, allowing U.S. insurers and banks to operate wholly owned subsidiaries in the mainland. This also includes a provision that the U.S. will expedite reviews for Chinese financial institutions wishing to do business in the U.S.
  • The U.S. will not implement the phase 4b tariffs that were scheduled for December 15, 2019, and the U.S. will reduce the tariff rate to 7.5% from 15% on the phase 4 tariffs implemented September 15, 2019.
Based on the provisions outlined, the U.S. seems to be the clear winner by forcing Chinese concessions. The mandatory increase in exports to China should be a boost for both the manufacturing and non-manufacturing sectors in the U.S. and provide some relief to U.S. farmers. However, the deal may not be as solid when it comes to enforcement. The deal outlines a 3-phase dispute resolution that differs from traditional arbitration agreements and allows for the U.S. to re-implement tariffs as long as it is done “in good faith.” The agreement also allows either party to back out of the deal with just written notice if a trade retaliation is deemed to have been done in “bad faith.” 
 
The vagueness of the enforcement mechanisms and move away from arbitration makes the deal less sturdy than desired, and the guaranteed agricultural purchases could expose the U.S. to the World Trade Organization’s ire if it significantly hampers other countries, like Brazil’s, exports to China. Overall, the agreement is a positive and should buoy sentiment for a bit, but this deal’s enforcement mechanisms show that there is still an uphill battle for the U.S. in pursuing structural changes in China.

The International Monetary Fund (IMF) announced that global economic growth is expected to have a moderate pick up in both 2020 and 2021

On Monday, January 20, the IMF released its quarterly update to its World Economic Update detailing their expectation for global GDP to rise to 3.3% in 2020 and 3.4% in 2021, a modest uptick from 2.9% in 2019. The organization noted that some risks mentioned in its October 2019 update have partially receded, most notably the announcement of a U.S./China Phase One trade agreement and a lower probability of a no-deal Brexit. Additionally, monetary policy across major economies continues to support GDP growth and accommodate financial conditions. Furthermore, it is believed that global manufacturing and trade are near the bottom which should improve market sentiment going forward. Overall, the IMF’s outlook for 2020 remains positive, but the organization also stated that downside risks from increased geopolitical tensions remain prominent, particularly between the U.S. and Iran, as well as increased deterioration in relations between the U.S. and many of its trading partners. The IMF’s main theme for its economic outlook in October was “synchronized slowdown” and, given the seemingly cautious optimism for 2020, the theme currently stands as “tentative stabilization, sluggish recovery,” a reflection from the improved forecast for the next year. 

U.S. banks have kicked off the Q4 2019 earnings season

The largest U.S. banks as well as most large regional banks have now reported 2019 earnings. Revenue growth picked up in the fourth quarter after very little growth for most of 2019 with profitability remaining solid for the most part. Generally speaking, net interest income remains pressured due to the lower interest rate environment. Deposits at the large banking institutions are at an all-time high as they continue gaining market share over the smaller lenders. Loan growth remains slow overall but picked up slightly in Q4 2019. Solid growth in consumer lending was the highlight of 2019 for the large credit card lenders and was particularly strong in the fourth quarter thanks to record online sales between Black Friday and Christmas. Mortgage lending picked up somewhat in 2019, driven by refinancing. Interestingly, housing starts in December were at their highest levels since December 2006, with the largest gains recorded in the Midwest. Commercial and industrial loan growth was fairly weak in 2019, particularly in the second half of the year but is expected to pick up somewhat in 2020 given the de-escalation of the trade war between the U.S. and China. Fee income growth was supported by asset management, service charges, and credit card for most of the year, and capital market operations performed surprisingly well in the fourth quarter. 
 
For 2020, net interest income is likely to stabilize as the benchmark interest rates are expected to remain generally constant based on the latest Fed’s guidance. Overall loan growth is likely to remain modest (in the low single digits). Capital market operations tend to add volatility in results and depend heavily on the global macroeconomic expectations, and asset/wealth management businesses are expected to continue performing well. U.S. banks plan to remain highly focused on costs, and asset quality is likely to deteriorate somewhat given the extremely low levels of loan losses and the late stage of the business cycle.
All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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