On 15 January, the governments of the US and China signed a “phase one” economic and trade agreement as part of their continuing negotiations. The accord marks a temporary de-escalation of trade tensions between the two largest global economies. Nevertheless, ongoing US and Chinese tariffs will diminish the credit positive impact of additional exports to China for affected US industries. The pact will also have an indirect negative impact on Brazil's (Ba2 stable) agribusiness sector. Under the agreement, China pledged to increase US imports across four sectors (energy, agriculture, manufacturing and services) by a minimum of $200 billion over the next two years. However, both countries will keep a substantial amount of tariffs on one another's products, including US tariffs on $360 billion of Chinese imports that affect 40% of intermediate inputs that these four sectors use. As part of the agreement, the US reduced tariffs on $120 billion of Chinese goods to 7.5% from 15%. Additionally, the US and China suspended plans for new rounds of tariffs that had been set to take effect on 15 December 2019 but were delayed while the two sides held talks on the interim agreement. China will also temporarily exempt $660 million of US chemical products from tariffs. Committed increases in China's imports from the US will be the largest for the US energy sector, with additional purchases in 2020 amounting to more than 200% of the sector's 2017 exports and more than 400% in 2021. The agreement uses 2017 figures as a baseline for the additional purchases. The agreement calls for an increase of US exports of agricultural goods to China of roughly 50% in 2020 and 80% in 2021, and an increase in manufacturing goods exports of around 40% in 2020 and 60% in 2021. Ongoing Chinese tariffs on liquefied natural gas will make additional purchases challenging Liquefied natural gas: Within the energy industry, the phase-one agreement will have a particular effect on the growing US liquefied natural gas (LNG) export sector. Ongoing Chinese tariffs underpin the reluctance on the part of Chinese energy companies to contract with US exporters. This in turn reduces the number of global counterparties seeking additional US capacity and could slow the development of incremental LNG export facilities. The construction of an LNG export facility runs into the billions of dollars and, to date, lenders have been primarily willing to lend only to facilities with long-term contractual arrangements. At present, the tariffs' effect on existing US terminals is lessened by the fact that their capacity has already been contracted and, therefore, any impact is likely limited to spot cargoes. Increased farm product exports to China will be generally positive for US agriculture and agriculture related sectors Occurring in an environment of already-low crop prices and strains on farmers’ net income, additional purchases of US farm products will be credit positive for the agriculture and agriculture-related sectors. The largest crop to benefit from the new tariffs will be soybean products because exports to China have historically represented a large share of total US soybean production. Exports of soybeans declined significantly in 2018, following Chinese tariffs on US imports. US states: Increased agricultural purchases will be positive for major soybean-producing states, including Illinois, Iowa and Minnesota. Iowa will benefit the most because its soybean exports are much larger relative to its economy than for the other soybean-producing states. The positive impact would alleviate the overall strains on the agriculture industry that resulted from heavy spring flooding in the Midwest. Protein: US protein production was on the rise in 2019 in response to the reduction of over 40% of China’s swine herd in 2019 due to the African swine fever. However, US protein exports were hampered by China’s retaliatory trade tariffs on pork products, which significantly increased cold storage inventories and pressured prices. Any increase by China in imports of US meats would help reduce US supply levels and boost protein prices, benefitting companies including Tyson Foods, JBS and Smithfield Foods. But since the agreement did not reduce tariffs on US pork, they remain an obstacle. Commodity trading companies: The agreement will have differing effects on commodity trading companies such as Archer Daniels Midland Company, Cargill Incorporated, and Bunge Limited. China’s pledge to increase exports from the US will require substantial export redirection away from other countries, primarily Brazil. ADM and Cargill will benefit to the greatest degree because they have a much larger market share in the US than in Brazil. Bunge has a large existing market share in Brazil and therefore will incur a negative impact from lower Chinese demand. Agricultural-related securitizations: The trade deal is likely to increase farmers’ net income and the residual value of their equipment, supporting the performance of US securitizations backed by agricultural equipment loans and leases. Agricultural equipment such as tractors, combines, and seeding and harvesting machinery in general secures at least 75% of the financing contracts in 20 farm and construction equipment securitizations, with a collateral value of $7 billion. Financing for construction equipment makes up the rest of the ABS collateral, creating diversification in the collateral pools. Sponsors of US agricultural equipment ABS include John Deere Capital Corporation, CNH Industrial's indirect subsidiary of CNH Industrial Capital America LLC, and DLL. Additionally, the agreement will have a credit negative impact on Brazilian agribusiness receivables securitizations because the reduced demand for agricultural products from Brazil will affect sales by Brazilian producers and distributors, and therefore their ability to pay the securitized trade receivables. However, certain transactions benefit from credit insurance, which will mitigate this risk. Agricultural banks: Additional Chinese purchases of US agricultural products will be credit positive for the Federal Farm Credit Banks, a group of four banks (AgriBank, The Farm Credit Bank of Texas, AgFirst Farm Credit Bank and CoBank) and 68 lending associations that provide loans and other financial services to US agricultural producers and cooperatives, and rural communities. As of 2018, the system provided about 40% of all US farm business credit. Increased purchases of US soybeans will likely have a larger effect on AgriBank than on the other three FCS banks because it has a proportionately larger loan portfolio in the top soybean-producing states of Illinois, Iowa and Minnesota. North American fertilizer producers: Shifting agricultural production to the US from Latin America will have a modest positive impact on North American fertilizer producers because farmers will likely plant more acres in the US as a result of the trade deal. Performance was already expected to be well above 2019 levels due to the massive floods in the Midwest last year. Among rated fertilizer producers, Nutrien, Mosaic Company and CF Industries Holdings should benefit to the greatest degree due to their larger market shares in the US. Nutrien’s farm store network will perform much better in 2020, largely on the back of poor weather conditions in 2019. US ports: The agreement is positive for the ports sector generally as it both slightly rolls back certain tariffs and reduces the risk of escalation in trade tensions, in addition to the likely positive impact on broader business and consumer confidence. The agreement will particularly be beneficial for ports on the West Coast. The largest beneficiary would be the Port of Oakland in California, one of the largest exporters of US agriculture, and the Northwest Seaport Alliance. Oakland is a major exporter of US agriculture and is more dependent on exports than most US ports, although it also can withstand trade-related cargo volatility because it is both a landlord port with significant fixed revenues and an operator of a medium hub commercial airport. The Northwest Seaport Alliance, a joint venture between Washington state's Port of Seattle and Port of Tacoma, is also a large exporter of agricultural products to China and, like Oakland, is organized as a landlord with high levels of fixed revenues from tenants. Ports on the Gulf Coast are also large exporters of bulk agriculture. These include the Port of New Orleans, which is a large steel and aluminum import gateway, and is at the outlet of the Mississippi River, where barges carrying agriculture for export transload before ocean transport. The nearby Port of South Louisiana will benefit more than the Port of New Orleans due to its higher exposure to agricultural products and narrower financial margins. In Georgia, the Port of Savannah exports 40% of all US containerized poultry exports, with China as its top destination, and would likely see export volumes benefit. Overall credit impact on manufacturing and airlines sectors will be muted China has committed to purchasing a minimum $78 billion of manufacturing goods over the next two years, an average of 50% annual increase in manufacturing imports compared to the 2017 baseline. The agreement applies to industrial machinery, electrical equipment, pharmaceutical products, aircraft, vehicles, optical and medical devices and iron and steel products, and other manufactured goods. The largest impact will fall on aircraft, which accounts for 24% of the affected imports. Manufacturing: The agreement will be positive for US manufacturing because it prescribes a material increase in exports of manufactured goods to China from the US. However, the overall effect on US manufacturing firms will be muted for two reasons. First, many US firms have implemented production strategies to manufacture close to markets into which they sell in order to simplify supply chains and establish a local presence in markets such as China. Thus, US manufacturers may be averse to undertake costly and disruptive changes to their supply chains in order to increase the mix of US-manufactured goods sold to the Chinese markets. Second, the agreement does not address the ongoing tariffs on Chinese manufactured goods that the US imports. The US imported approximately $170 billion of manufactured goods from China similar to the types covered under this agreement, substantially exceeding US export levels to China. Many of these imports include components critical to US-based manufacturers, and are still subject to tariffs on arrival. This results in a continued burden on US firms as higher input costs may increasingly pressure margins as those tariffs persist. Airlines: The agreement has the potential to stimulate an increase in passenger demand for air travel between the two countries but is unlikely to result in US carriers increasing capacity to and from China. US airlines have trimmed their capacity to China and Hong Kong in the past 12 to 24 months because of slowing demand and a weak fare environment. The ongoing civil unrest in Hong Kong has compounded the pressure on passenger demand to the region. Any improvement in demand will contribute to improved pricing power and thus higher fares. The effect on demand is uncertain at this time. For the 2019 fourth quarter, Delta Air Lines reported a 0.5% decline in revenue for its Pacific region inclusive of a 4.4% decline in unit revenue, mainly because of softness in China. The pace of the revenue decline in the Pacific slowed in the fourth quarter compared with the third quarter, when revenue fell nearly 4%. The improved trend resulted from performance in Asian markets other than China and growing sales of premium offerings. American Airlines and United Airlines will likely report similar trends when they report fourth-quarter results in the coming weeks. The exhibit illustrates how the ongoing US tariffs on imports from China affect industries that could benefit from increase in purchases by China under the phase one agreement. The yellow and orange bars show estimates of the imports under tariffs as a percentage of total imports from China by US industry. The sectors highlighted in blue have the potential to benefit from the trade agreement. However, the ongoing tariffs on intermediate inputs imported from China will diminish the positive effect on these industries. Courtesy of Moody's