Source: Evercore ISI
The two leaders are expected to discuss the ongoing U.S. China trade war. Talks of a possible trade deal fell through back in May after the Trump administration hiked tariffs to 25% from 10% on about $200 billion worth of Chinese imports. China retaliated with higher tariffs of its own. President Donald Trump has also floated the idea of slapping tariffs on an additional $300 billion in Chinese imports.
Evercore ISI strategist Donald Straszheim said there are three potential outcomes from the Trump-Xi meeting: First, the U.S. agrees to hold off on slapping additional tariffs on Chinese goods for an indefinite amount of time. Second, the U.S. holds off on additional levies for a fixed amount of time. Third, the U.S. makes no mention of the additional tariffs in its post-meeting statement, which would suggest the administration will move forward with them "ASAP."
The most likely scenario from the Trump-Xi meeting in Japan is that the U.S. agrees not to impose tariffs on the additional $300 billion in Chinese imports without a concrete timeframe, Straszheim said.
Straszheim says this outcome has a 45% probability of taking place and ranks as the second-most favorable for Trump, Xi and the market.
"This is a jointly recognized time-out. Higher tariffs by the US are not implemented for maybe a short time, maybe a long time," Straszheim said in a note. "Real negotiations would presumably be re-launched. This is maximum uncertainty on tariffs, and to the Markets and others (in China, the US and Rest of World), but provides maximum flexibility to Trump."
Scenario 2: US holds off on additional China tariffs for a fixed number of days, talks restart (35% probability)
The second-most likely scenario is the two sides agree to restart trade talks with the U.S. holding off on additional tariffs for a fixed amount of time, Straszheim said.
There is a 35% chance of this outcome taking place and it would be the most favorable to Xi and the stock market as it would give them time to "breathe." It would also give the market "certainty for more negotiation (and assessment) time." But what makes this scenario unlikely is it would hamstring Trump in future negotiations.
"Trump has no flexibility during this period," Straszheim said.
This scenario — along with the first one — would likely benefit trade-sensitive names like Caterpillar and chipmaker stocks. These stocks have underperformed the broader market recently amid the lingering trade fears.
Scenario 3: US and China make no mention of additional tariffs, suggesting they will be implemented soon (20% probability)
This is the worst-case scenario for both Xi and the market as it deals another body blow to the Chinese economy and increases fear among investors that the trade conflict will drag for longer.
"This would be bad news, suggesting a near breakdown on remaining differences," Straszheim said. "At best the two sides would 'maintain communications.'"
"In this outcome, no mention of new US tariffs is included in the statements, suggesting the US will proceed with tariffing $300 bln," he added. Straszheim expects Trump to slap a 10% tariff on those additional Chinese imports in this scenario.
Assets like gold and Treasurys would benefit from this outcome as stocks would fall under pressure. Gold has been on a tear lately. The precious metal hit its highest level since 2013 on Monday. Investors have also plowed into Treasury yields recently, pushing the benchmark 10-year yield to its lowest level since 2016.
This is the least-likely scenario — only a 20% chance of happening — given the political and economic implications, the strategist said. It is not, however, outside the realm of possibility.
"This is fluid; surprises are not ruled out," Straszheim said.