On 15 January, the governments of the US and China signed a “phase one” economic and trade agreementaimed at reducing bilateral tensions between the world’s two largest economies that have weighed on global growth over the past two years.The deal is positive for global emerging market (EM) credit conditions, because it reduces the risks of a renewed escalation in tariffs and other punitive measures. Nonetheless, the relatively minor concessions made under the agreement suggest that scope for a flare-up in frictions between the two countries will persist.Reduced political uncertainty as a result of the deal will strengthen global risk appetite and bolster the ongoing rally in EM capitalinflows. Total EM debt and equity inflows had already recovered to nine-month highs in January and, as shown below, havepreviously responded favorably to periods of thawing US-China tensions.The agreement could set the stage for a more sustained strengthening of business confidence, trade volumes and investment flows.However, the relatively minor concessions made under the agreement suggest that a potential flare-up in frictions between the two countries cannot be fully discounted. US technology restrictions remain a possible flashpoint as the roughly $360 billion of products that remain on the tariff list are largely drawn from sectors such as electrical machinery, automotive parts, electric integrated circuits and parts, and electronic parts. These existing tariffs will continue to hurt the revenue and earnings growth of Chinese producers in the tech sector. Other potential sources of non-trade friction include persistent US concerns of state influence in the Chinese economy.China is incentivised to raise US imports gradually since, if US imports replace domestically produced goods and services, this could exacerbate downward pressure on producer prices, depressing corporate earnings in affected sectors such as energy, chemical goods, auto and agriculture goods. The potential increase in US imports could also put additional pressure on China’s emerging current deficit, which will challenge long-term financial stability.Finally, China’s pledge to increase exports from the US in these categories equates to an approximately 113% rise in two years over2017 levels. This is unlikely to happen organically, and will require substantial export re-direction away from other countries to the US.This will likely be negative for EM economies with large agricultural and energy exports to China, such as Russia and the Middle East.With US presidential elections also scheduled for November, we do not expect a complete rollback of US-China tariffs in the comingmonths, which suggests that a major resurgence in the EM manufacturing cycle is not on the cards in 2020. According to the agreement, China will increase purchases of US goods and services across four sectors by “no less than” $200 billionabove 2017 levels. Manufactured imports will represent the largest component in nominal terms, with committed additional purchases of no less than $78 billion. China will also increase purchases of energy products by no less than $52 billion, agricultural goods by $32 billion and services by $38 billion (below). While the agreement states that the US will modify its tariff actions “in a significant way,” the country’s 25% tariffs on $250 billion of Chinese imports will remain in place, as well as a 7.5% levy on an additional $120 billion of products.Beyond trade, China has also committed to refrain from competitive devaluations and to enact structural changes to the protection of intellectual property and the transfer of technology. Some of these commitments are consistent with policy initiatives that the Chinese government had already unveiled before 15 January, including the implementation details of the Foreign Investment Law, a new list of US goods with exemption from additional tariffs, additional import tariff cuts and a further opening up of the domestic life insurance market.Source: Moody's