Heavyweight Trade Battle Stuns Yuan and Markets, but is China Really on the Ropes?

In this week's blog, we assess the heightened trade war tensions and the depreciation of the yuan.

Mike Welle, Senior Portfolio Manager

"We may well be at the most dangerous financial moment since the 2009 Financial Crisis". This a recent observation from former U.S. Treasury Secretary Larry Summers as he viewed trade developments between the U.S. and China.

The trade dispute has the full attention of financial markets and has become an increasingly influential factor on Federal Reserve policy - this past week presenting fresh reminders. We will briefly review a timeline showing the escalations of trade tensions, focusing on the most recent events which have stoked concerns related to the weakening yuan.

Markets have been volatile with the Dow Jones Industrial Average down nearly 1,500 points and 10-year U.S. Treasury yields falling 35 basis points over the course of four trading days. The declines were precipitated by the latest face-to-face trade talks - the 12th round between the two sides since the trade war started in early 2018. Discussions centered on select issues, including forced technology transfers and Chinese telecommunications giant, Huawei. The outcome was one of frustration, making little progress toward finding a near-term resolution.

Infographic: U.S.-Chinese Trade War Keeps on Escalating | Statista You will find more infographics at Statista

 

The timeline above shows a tremendous escalation, most notably over the past year. If the latest threats on Chinese consumer goods become effective on September 1st, virtually all U.S. imports from China will be covered to different degrees. Each time President Trump has pressured China with increased tariffs, he has been met with a response. Already taxing nearly everything imported from the U.S. - cumulative tariffs of $110B vs. American exports of $120B in 2018 - China hit back by revealing it had stopped buying U.S. farm products entirely. Further, the Chinese allowed its currency to weaken beyond seven yuan to the dollar, a key level of support that has held for more than a decade. This symbolic message has gripped markets with a fear the Chinese currency could be used as a weapon in the trade war.

A weaker yuan makes Chinese goods cheaper for overseas buyers. We have seen estimates peg China's economic gain at approximately $15B for every 1% depreciation in the yuan. Interestingly, the roughly 2% decline in CNY since August 1st  would be worth about $30B - a complete offset to the $300B September 1st tariffs. Of course, China should also be mindful of the capital outflow pressures that go along with this potential strategy - 2015 being a good reminder. On the other side of the coin from a U.S. perspective - a stronger dollar but less competitive American exports. Is China really on the ropes, or is this trade deal looking as elusive as ever? Maybe that's what markets are sniffing out.

 

Sources

Bloomberg

DailyFX, USD/CNH Above 7.000: Trade Wars are Good, and Easy to Win, August 7, 2019

Statista, U.S.-Chinese Trade War Keeps on Escalating, August 2, 2019

Washington Post, The U.S. China Trade War is Getting Ugly. Is This Really the ‘most Dangerous Financial Moment Since 2009'?, August 6, 2019