Chief economist update: Thrilla in Osaka

Financial markets action over the past few days leading up to the June G20 meeting in Osaka - where the main game is between the trade talks between the two biggest economies in the world, the United States and the People's Republic of China - suggests participants are hoping for the best rather than preparing for the worst.

Face-to-face negotiations are, after all, more polite than tit-for-tat tweets. But at the end of the day, those hopin' and wishin' and prayin' that the tariffs would just go away and watch Trump and Xi kiss and make up are sure to be disappointed. The uncertainty over an escalation/de-escalation of the war on trade would not suddenly vanish after Trump talks to Xi at the G20.

Nevertheless, an agreement to extend trade talks beyond the G20 summit is a good enough outcome.

Talks of a trade deal in the dying months of 2018, as well as the Fed pause and later speculations of rate cuts, have propelled the S&P 500 index to a record high.

But the reaction to the deal or no deal talks is more pronounced in China's equity market. The Shanghai composite index soared to a 14-month high of 3,263.12 points in mid-April (an outstanding 34.4% rally from the start of 2019) on trade deal hopes.

The resumption of US-China trade hostilities-when US tariffs on about US$200 billion worth Chinese goods increased from 25% from 10% on 12:01 on May 10 and Trump is reportedly readying the paperwork to slap a 25% tariff on all remaining imports from China worth around US$325 billion - sent the Shanghai composite index dropping by 13.4% from its 2019 high.

China's benchmark equity market index has since recovered 6.4% of its losses resulting from optimism over the Trump-Xi meeting at the G20.

The Yuan/US exchange rate displays the same history - it has strengthened versus the US dollar amid positive expectations over US-China trade talks. The yuan/US$ exchange rate has risen by 0.8% after it dropped to a six-month low of CNY6.9327 in early June.

Whether these optimistic reactions continue depend largely on the Trump-Xi meeting in Osaka.

Both leaders must be aware of the negative repercussions their stoush are having on their domestic economies but domestic considerations prevent them from shaking each other's hand.

Nationalism and national pride dissuade Xi from kowtowing to US demands. Trump, seeking re-election, would want to make good and deliver on his trade promise.

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