Jefferies strategist expects China to fulfill its U.S. trade deal commitments for an unexpected reason
For months now, trade experts have wondered if the U.S. and China will make good on the pledges outlined in phase 1 of the trade deal. The pact, signed in January, requires China to increase its imports of American goods by a combined $200 billion within two years.
The two sides reiterated their commitment to the deal this week, but doubts remain because China is far behind on its purchases through the first half of 2020, according to the Peterson Institute for International Economics’ trade deal tracker. It has bought only 23% of the goods it should have purchased by now.
Even with those shortfalls, Jefferies chief global equity strategist Sean Darby says his confidence in the superpowers fulfilling phase 1 of the trade deal is “actually quite high.” Why? He points to weeks of torrential rains and catastrophic flooding in China. The devastating conditions have ravaged farmland, meaning China must import large amounts of agricultural products from the U.S., since farmers in China will not be able to produce and deliver enough food for the population.
That new demand will benefit “Mr. Trump and the farming community in the United States because it does open a door for the mainland to import the much larger amounts of agricultural products from the United States,” says Darby, who’s based in Hong Kong. The Trump campaign touts the trade deal as one of the President’s crowning achievements, one that could bring economic relief to American farmers whose livelihoods were hit hard by trade war tariffs.
In an Eastworld Spotlight interview with Fortune‘s Clay Chandler this week, Darby also talks about Hong Kong’s stock market, U.S. pressure on Chinese firms, and the possible fallout from U.S. actions against Chinese telecom equipment giant Huawei. The conversation below has been edited for length and clarity.
Fortune: A lot of people over the past year have lamented the “death of Hong Kong,” which has been hit hard by the pandemic, concerns about the new national security law, and rising U.S.-China trade tensions. Yet the Hong Kong stock exchange just announced a record profit. What’s going on with the Hong Kong market and what’s your outlook?
Sean Darby: A bit like the rest of the world, there’s been a disconnect between the equity market and what’s been happening in the real economy. And part of that is a function of the U.S. Federal Reserve policy, which has been extremely loose and expansionary because we’re paired to the U.S. dollar. Secondly, we’ve benefited from China’s economy being one of the first to recover from COVID-19. Because most of the earnings of companies on the Hang Seng Index are generated either in China or overseas, that has also been a reason why you’ve had this very big displacement in the performance of the equity market despite near recession levels within most parts of the economy.
We feel that the Federal Reserve policy is going to remain extremely loose. And China will be celebrating the centenary founding of the Chinese Communist Party in 2021. It’s clearly got to have the economy doing very well. So in terms of the profit cycle and the external environment for Hong Kong, things are still in place to be reasonably good.
On the ground, we’ve been frustrated by a second wave of COVID-19 cases, which pushed back the recovery in many ways…The key litmus test for us is whether we can open the border with Guangdong and the hinterland, or what we call the Greater Bay Area. If that occurs, then I think we can really say that the end of the recession pretty much [will be] the third quarter of this year.
President Trump said recently that the Hong Kong exchange would no longer be successful since the U.S. has ended its special economic status with the city. But in some ways, it looks like the opposite is happening. Is it the case that the more U.S. policymakers try to push Chinese companies off U.S. exchanges, the better it is for Hong Kong? What’s your read of the situation?
I think that was always going to be, at some point, part of the route China would take; returning companies to the mainland, into Hong Kong, purely for the fact that they were also part of their industries and their economy. So in many ways, Mr. Trump’s actions and the actions by the [U.S. Securities and Exchange Commission] have actually caused that to be sped up very, very rapidly.
The longer-term issue is whether there are going to be more difficult issues for the domestic banking system here [in Hong Kong] in dealing with counterparts in the United States or overseas. That is still the big question mark; how far will sanctions move from the United States toward Hong Kong?
What does that imply for Hong Kong as a financial capital? There has been much speculation that Hong Kong might lose out to Singapore, Tokyo, or Seoul. Do you see any of those cities as potential alternatives to Hong Kong?
To build up the infrastructure of a financial center takes decades. You need to have the confidence of very strong regulatory banking; you need to have the architecture of a very well-run banking system. And in particular, for this time zone, [you need to have] access to China’s renminbi. The flow of Chinese currencies has given Hong Kong a unique advantage over its peers. So Hong Kong stock exchange’s Connect program, which we have for equities and bonds and now even wealth management products, has allowed Hong Kong to have this dual exchange rate system that operates at dollar pay and has almost unlimited funding of RMB from China. That unique setup, that infrastructure, is going to be hard to compete away.
The difficulty for Hong Kong, maybe 24 or 36 months from now, is that mainland bourses, both in Shenzhen and Shanghai, are looking enviously at the IPO activity, the trading turnover that Hong Kong has established. There’s a sort of turf war between Hong Kong and its sister bourses on the mainland. I think that’s going to be where Hong Kong is going to find itself competing, rather than the financial centers in Tokyo or Singapore.
Would Shenzhen and Shanghai be able to tap into the global capital market?
The investor base in China has itself grown commensurately. We have to recognize that retail turnover is a very large part of mainland activity, more so than anywhere else in the world. But [the Chinese market is] also becoming highly institutionalized, and even China insurance companies now can have a weighting in equities of up to 35%. If we had this…tension between the U.S. and China five or six years ago, it might have been impractical for these companies to have quickly re-listed [in China]; we would not have had the depth of the markets in the mainland to absorb such a large amount of capital requirements. But it’s fortuitous now that the depth of the market in the mainland and in Hong Kong have broadened so significantly over the last five years.
Despite all of the rhetoric between the United States and China, China has actually welcomed foreign companies that want to be engaged in the financial industry because it seeks a greater depth for its capital markets. In many ways, that’s not going to change over the next couple of years because it’s very important for China to feel that its capital markets are [entering] the mainstream. Ultimately, they want to ensure that the Chinese currency itself becomes part of the mainstream asset class, a mainstream means of exchange.
The end game of the long-run view from China is that they should continue to welcome foreign companies participating in their capital markets because ultimately it brings the bigger prize of the RMB becoming more internationalized, and therefore, the economy becomes less dependent on those flows of dollars moving around the system.
You mentioned the face-off between the United States and China. That really seems to be escalating as we move into the U.S. presidential election. One flashpoint has been a fresh wave of U.S. restrictions against Huawei. What kind of repercussion do you see from it?
It is actually quite a complicated way of trying to control China’s emergence because there are lots of unintended consequences that can come back to the United States. The first thing to highlight is that you introduce a lot of idiosyncratic risk on corporates globally because it is not unthinkable that China itself will set up its own entities list as the Americans have done, and restrict the ability of American companies to operate in the Chinese domestic market.
It is only going to force Chinese authorities to speed up the delivery of local tech components within their own economy. So eventually, they won’t be as dependent on the United States for their inputs or their products. And that in itself will actually be a negative for the U.S. economy.
China has fallen behind in its purchases of American agricultural products and energy imports. Can it make that up and fulfill the phase 1 trade deal as we get closer to November?
Our confidence level on the fulfillment of the phase 1 trade deal is actually quite high. Certainly, our discussions with people on both sides is that both parties wish to honor it. Initially after COVID-19, simply because the Chinese economy was not functioning and couldn’t actually import a lot of these products, there was a lag in terms of China’s commitment or peer-to-peer commitment to phase 1. Now, by accident, the ongoing flooding and the terrible conditions in some of the provinces after these very dramatic rainstorms [have] meant that a large part of the agricultural base in China will not be able to deliver a sufficient amount of food for the population. And measures from China in recent weeks—domestic data, trying to curb food consumption—are hinting that that’s going to be a much deeper problem for the economy. And that falls very nicely for Mr. Trump and the farming community in the United States because it does open a door for the mainland to import the much larger amounts of agricultural products from the United States.
So I think, by accident, out of terrible weather conditions, the phase 1 trade deal probably looks to be in the bag for Mr. Trump, and certainly he can point to a great deal of success in getting that sealed and delivered by the Chinese coming into the November election.
This story is part of Eastworld Spotlight, a series of conversations on matters of business, tech, and finance with executives, experts, entrepreneurs, and investors in Asia. Subscribe to Fortune’s Eastworld newsletter to get them in your inbox.