Editor's Note: Jimmy Zhu is chief strategist at Fullerton Research. The article reflects the author's opinion, and not necessarily the views of CGTN.

China and U.S. reaching a "substantial phase one" progress last Friday may cause a portfolio re-shuffling from safe haven to riskier assets in near term, even as many fundamental issues remain unsolved.

"Phase one" trade deal will have very little impact on the economy

Markets welcomed the unexpected announcement of progress in the U.S.-China trade negotiation, as stocks rallied with the offshore yuan, and bond yields climbed.

Further escalation in trade tension has stemmed, for now, which definitely offers some relief to the already deteriorating global economy. But it's far from enough to arrest the slow down for three basic reasons:

-       It's a truce, not a de-escalation in trade tension. Existing tariffs placed by the two sides remain. Not increasing the tariff is not equivalent to waiving it. The current tariff put in place would continue to trim growth activities worldwide.

-       JP Morgan global manufacturing Purchasing Managers' Index (PMI) has been below the key 50-level for five months, with Institute for Supply Management manufacturing PMI dipping to the lowest level since 2009. Many issues will not be fixed based on what has been agreed in the latest trade negotiation.

-      U.S. President Donald Trump's trade policy has never been clear, even now. On September 20, Trump dismissed the idea of "partial deal" with China as he said he was looking for a complete deal, but he changed his mind within a month.

At this stage, there is still no clear evidence as to what led to the breakthrough, as details of the agreement would only be released in the next few weeks. The increasing number of Americans supporting the impeachment inquiry and slower economic data in the U.S. could be two major reasons behind Trump's concession in the U.S.-China trade negotiation. He needs a "milestone" in the trade negotiation process.

Xinhua news reported that the China-U.S. trade relationship still faces many uncertainties ahead, which require China to have both patience and strategic focus. It also said the two countries' relation has become more complex, and will take a long time to address these issues.

Earlier in August, the yuan weakened above 7.0 versus the U.S. dollar for the first time since 2008. Chinese yuan, especially offshore yuan, has been following the progress on trade negotiations closely since beginning of the year. 

The U.S. 10-year government bond is one of the most popular safe-haven assets. Its move with the CNY/USD has been in the same pace for all the time since early January. Global economic data currently stands quite similar as those in two months ago. Thus, the trade truce is likely to lift the Chinese yuan back to the 7-level versus the greenback in coming weeks.

Some market participants may argue that any appreciation in yuan would harm export and manufacturing activities amid an already deteriorating external demand. However, data in the past two years show that the yuan's impact on Chinese outbound shipping activities has been minimal.

The U.S. dollar index dropped 0.5 percent, the biggest weekly decline in five weeks, to 98.30 last week. Its move since the beginning of second half of this year has been in tandem with typical safe haven assets, such as U.S. 10-year government bond yield and gold. 

The U.S. dollar's usually holds an inverse relationship with gold. However, the positive correlation with the two reached 0.684 in past four months. Thus, risk sentiment in the capital market is one of the key factors that is driving the dollar. A trade truce is likely to push the global stocks higher in near term before the U.S. Federal Open Market Committee (FOMC) meeting this month, and some flows may shift into Emerging market equities, while the U.S. dollar may further retrace amid potential improvement in risk sentiment.

Visible bonds' downside risk seem amid trade war truce ahead of the FOMC meeting

Global recession fears and trade war are major reasons behind the bonds' rally in past months, as traders bet on central banks' liquidity floodgate opening. However, major central banks were showing split views last month when more policymakers refuse to further implement easing measures. A truce in the trade war could provide more reasons against further easing.

Financial condition in the U.S. is improving. The U.S. 2/10 government bond yield spread widened by 8 basis points (bps) to 13 bps last Friday, reducing the need for the U.S. Federal Reserve to cut rates again this month, after it cut it in July and September. S&P 500 closed at 2970.27 on Friday, only 1.9 percent below the historical level on July 26, while the U.S. Dollar index dipped 1.4 percent since the beginning of October.

Still, rates markets predict a 70 percent probability on Fed to cut again this month, and a truce in the trade war may mean an immediate rate cut is off the table. If that happens, it could send the U.S. 10-year bond yield toward 1.9 percent from the current 1.729 percent.

(Cover Image via VCG.)