G20 Summit finally arrives - what does it all mean?

G20 Summit begins

Market attention turns, almost singularly, to this weekend’s G20 Summit, today. There are numerous issues with significant financial market and global economic implications to be discussed at the event – the general concern about a global economic slow-down the overarching one. But of course, at the centre of everything, almost eclipsing the Summit’s primary purpose, is the highly anticipated meeting on Saturday afternoon between US President Donald Trump, and Chinese President Xi Jinping. For markets, the outcome to this meeting guides the future direction of the global economy, and the fundamental strength of financial markets.

Markets sit and wait

The week thus far in the financial world has broadly been defined by positioning for this high-profile event. The flurry of activity that characterized last week’s trade, following the litany of central bankers – most pertinently at the US Federal Reserve and European Central Bank – who pledged to provide monetary policy support to the ailing global economy, has diminished. Global equities have traded sideways, bond yields have floated higher, the USD has reversed some of its losses, and gold prices have retraced some of its gains. The next big cue is being awaited, to build an outlook for market fundamentals.

The intractable issues

And at least for now, and until the US Fed reclaims the onus approaching its July 31st meeting, market sentiment hinges on the outcome of that Trump-Xi meeting. The issues hovering-around the meeting are numerous, and complex: protectionism and perceived trade-imbalances; competitive currency devaluations; intellectual property theft and forced technology transfer; cyber espionage; freedom of navigation. And all of this within the broader narrative of one aging-Superpower attempting to control the rise of another burgeoning-Superpower, by forcing it into an existing world-order it had little say in creating, and wishes to gradually modify to serve its own growing strategic ambitions.

The new-normal

Surely, only the most zealous of idealists believe that the power-struggle between the US and China can truly be resolved. The dynamic between the two-nations is Machiavellian, and a matter of realpolitik. As has been quoted ad nauseum in the market: we are right in the middle of Thucydides Trap; and perhaps at the beginning of a new-age of bipolarity. Future disruptions in international political economy and financial markets ought to be (and probably are already) expected. But what about the more immediate future? The issue now for financial markets is how this weekend’s events will impact global growth, more-or-less, now.

The best case

The best-case scenario is that the US and China manage to negotiate and finalize a deal this weekend. Tariffs are removed; and new-rules are drawn-up between the two-nations about trade-relations, currency intervention, and intellectual property rights. Stocks markets spike across the globe, pushing the S&P500 to new all-time highs, and the ASX 200 to new 11-year highs, as the earnings outlook improves, especially for cyclicals and growth-stocks. The Yen and other safe-haven currencies fall, along with gold-prices, as the USD lifts with US Treasury yields as bets of rate-cuts from the US Fed unwind. Commodity prices jump, probably supporting an overall outperformance in the AUD.

The worst case

The worst-case scenario is that trade-talks and diplomatic relations break-down at the summit, and the trade-war escalates. President Trump sticks to his word, and applies tariffs to the remaining $US300b worth of Chinese imports currently not being taxed; and the Chinese respond in kind on a proportionate value of US imports. Stock markets tumble, especially in China, even while global bond yields fall, as markets increase their bets of immediate central bank support to ward-off recession. Gold lifts-off; oil, agricultural products and industrial metals drop. And the Japanese Yen goes-on-a-tear across the board, especially against growth proxies like the AUD, NZD and CAD.

The base case

Both of these scenarios are crude representations of potential extremes. They are what, in market-parlance, might be considered “tail-risks”. The likeliest, and therefore expected outcome, at this weekend’s G20 is one where nothing is agreed upon, but niceties are exchanged, as well as pledges to stall the trade-war’s escalation and return to the negotiating table. A relief rally in risk assets like stocks, corporate-credit, growth-currencies, and maybe even the USD, likely resumes; while safe havens pare gains, as focus returns to watching global growth indicators, anticipating earnings-season, as well as trying to pick exactly when global central banks will cut interest rates next.