Bloomberg reported this week that to no one’s surprise, China is responding to U.S. tariff threats. On Monday, it let the yuan tumble to the weakest level in more than a decade and asked state-owned companies to suspend imports of U.S. agricultural products.
The moves antagonized president Trump, of course, who then Twittered that China’s “currency manipulation will greatly weaken China over time!” He has previously criticized Beijing for not keeping to promises to buy more U.S. crops.
The impact on markets was immediate, and large. Stocks and emerging-market currencies sank on concerns over a prolonged conflict, while “haven assets” including the Japanese yen, U.S. Treasuries and gold climbed. Investors increased bets on Federal Reserve interest-rate cuts.
“It’s among the worst-case scenarios,” said Michael Every, head of Asia financial markets research at Rabobank in Hong Kong. “First markets sell off, then Trump wakes up and this all gets far, far worse.”
Semiconductors, with direct exposure to trade, and banks stocks, which are sensitive to interest rates, were among the decliners. The biggest U.S. banks slid, with the KBW Bank Index dropping as much as 4.1% to the lowest since June 4. Bank of America Corp. led index decliners, with a drop of 5.5%, the most since Dec. 4, while Citigroup Inc. shed more than 4% and JPMorgan Chase & Co. slipped 3.8%.
Agriculture equipment makers Deere & Co. and AGCO Corp. tumbled as China suspended imports of U.S. agricultural products. The escalating tensions are also a major risk for the U.S. automotive industry. According to UBS’s Global Wealth Management Chief Investment Officer Mark Haefele, the latest spat raises the possibility that "tariffs could also be placed on auto imports."
On Tuesday, Bloomberg cited Chris Krueger of Cowen Research who called China’s retaliation “massive,” adding that “on a scale of 1-10, it’s an 11,” and cited both the pull-back by state buyers of ag products and “increased anecdotal evidence that the Chinese government is tightening its overview of foreign firms.”
“While there were measures that could have been chosen with larger direct effects on supply chains, the announcements from Beijing represent a direct shot at the White House and seem designed for maximum political impact,” Krueger said.” We expect a quick (and possibly intemperate) response from the White House, and consequently expect a more rapid escalation of trade tensions.”
“There now will be increased expectations that the Fed will cut again in September to offset the drag caused by this escalation in the trade war,” he added. “Such moves will only be a partial, lagged offset to the recessionary headwinds a cycle of retaliation would cause.”
Krueger also added that “the next stop on the currency manipulation road is probably off the map.” He expects Trump’s “drumbeat on currency” will get louder, using a “charge of currency manipulation to justify some combination of (more) tariffs, investment restrictions and export controls.”
The harder line emphasizes a growing feeling in Beijing that “Trump can’t be trusted” to cut a deal and that China would be better off waiting to see if a Democratic presidential candidate--many of whom have criticized the use of tariffs--takes office. The halt in agricultural purchases
The onshore yuan weakened 1.4% to 7.0391 a dollar on Monday morning after the PBOC set its daily reference rate at a weaker level than 6.9 for the first time since December.
“Breaking seven is due to a mix of factors: an escalation of trade war, the softening of China’s economy and a willingness for the PBOC to tolerate higher volatility for the yuan,” said Larry Hu, head of China economics at Macquarie Securities Ltd. in Hong Kong. “The PBOC has entered uncharted waters, so it has to manage expectations carefully.”
By linking today’s devaluation with the renewed tariff threat, the PBOC “has effectively weaponized the exchange rate,” said Julian Evans-Pritchard at Capital Economics in Singapore. “The fact that they have now stopped defending 7 against the dollar suggests that they have all but abandoned hopes for a trade deal.”
Allowing the yuan to weaken is not without risk for China, Bloomberg said. A mid-2015 devaluation spurred capital outflows and destabilized global markets though tighter capital controls this time around should help prevent another exodus.
A cheaper currency also risks triggering yet more reprisals from the U.S., but the biggest damage from the trade war is the hit to business activity and confidence that comes from increased uncertainty, rather than the tariffs themselves, according to Wang Tao, China economist at UBS Group AG. For that reason, the weaker yuan may do little to offset the blow, she said.
China’s crop imports from the U.S. are another weapon at Beijing’s disposal. The administration repeatedly complained that China hasn’t made the “large quantities” of agricultural purchases that it claims Xi promised when they met in Osaka at the G-20 summit.
Those accusations are called “untrue” as Chinese companies have bought U.S. farm products, including soybeans, Cong Liang, Secretary General of the National Development and Reform Commission, said on Monday, although he notes that some deals haven’t been completed because the prices are not competitive.
“China is giving up on its softer diplomatic strategy and is no longer willing to be Trump’s punching bag,” said Chua Hak Bin, an economist at Maybank Kim Eng Research Pte. “Trump’s tariffs threats are backfiring and triggering a full-scale trade war.”
So, we will see. This week’s developments appear to make a new China trade deal even further out of reach and to increase tensions from the administration’s “get tough” policy as market shocks reverberate and which producers must watch closely as they emerge further and intensify, Washington Insider believes.
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