US-China trade war averted (for now), and the populists look set to take charge in Italy

By AMP Capital

Two unfolding political dramas we have been watching keenly over the last few weeks have been the rising trade tensions between the United States and China, and the trials and tribulations of forming a Government in Italy following the inconclusive March 4th election. Both have made progress of sorts.

President Trump’s high risk strategy of applying ‘maximum pressure’ in the US trade relationship with China has worked, at least for now. Our view was a trade war would be averted but only because China had no desire to escalate tensions as it looks to build its place as a significant global economic power.

Indeed, President Xi’s recent Boao Forum speech gave cause for optimism, especially on the vexed issue of intellectual property protection. The risk was that President Trump pushed things too far.

The agreement at the weekend to effectively stop “slapping tariffs” on each other is a positive outcome, though after two rounds of high-level talks it would be premature to fully declare the crisis averted.

There is still a lot of detail to work out and many contentious areas to work through, which allow plenty of scope for disagreements and tensions to re-emerge.

For now, both sides have agreed to continue talking to resolve bilateral economic and trade issues while adopting effective measures to reduce the merchandide trade deficit between the two countries. Sounds easy.

Meanwhile, in Italy the election outcome most feared by markets is on the brink of reality with the populist Five Star Movement and Nothern League parties poised to enter into a coalition agreement. One of the final sticking points – which of the two leaders would be Prime Minister – has been averted with the nomination of a third person, Giuseppe Conte, as Prime Minister. Mr Conte is a law professor and a political unknown, but is a friend of the Five Star leader Luigi Di Maio, and it seen as more acceptable to the public and the president, who must endorse the nomination.

While Euro exit was put on the back-burner during the election campaign, policies that would put the new government on a collision course with Brussels, including fiscal expansionism and the reversal of pension and labour market reforms, were not. Italian bond yields have risen sharply in recent days and ratings agency Fitch is reminding markets that its decision to downgrade Italy last year reflected increased political risk.

It still seems unlikely the new Government will push for exit from the common currency, but the period ahead looks fraught with confrontation. And as we said in the leadup to the election in March, a common currency is only as strong as its weakest link and Italy is the Eurozone’s weakest link. Reversal of reforms and fiscal profligacy will only weaken Italy further.

Perhaps more importantly, dealing with a more fractious Rome will inevitably divert Eurozone attention away from important current efforts, led mostly by French President Emmanuel Macron, to reform and strengthen the Eurozone. I expect we will have more to say about this in the next few weeks and months.

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Important notes

This blog post has been prepared to provide general information and does not constitute financial advice in accordance with the Financial Markets Conduct Act 2013. An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, 'AMP') make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.

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