Chinese Retaliation Roils Markets

Chinese Retaliation Roils Markets

Although yields drove markets towards the end of this week, last week and up until Wednesday, China was the motivating force behind the volatility. As we entered last week, China had struck back against Trump’s threat by declaring an end to all purchases of US agricultural products and allowing the yuan to depreciate against the dollar. To recap, because of slow progress during the July trade negotiations, President Trump announced that the US would hit an additional $300 billion of Chinese exports with a 10% tariff, effective September 1. To counter, the Chinese Commerce Ministry announced that China would completely stop buying American agricultural products. China’s response can be seen as an attack at the President’s base – rural America. China has been the largest importer of American soybeans and a top-three importer of pork. In total, they bought over $9 billion in US agriculture in 2018, ranking China fourth for farm exports.

In addition, China let its currency drop so that it trades at more than 7 yuan per US dollar, a value that has not been seen since 2008. While, the specific level does not have any economic significance, it carries symbolic weight. The weaker yuan makes Chinese exports less expensive in foreign markets. In addition, it helps offset the impact of US tariffs on Chinese products. To be clear, the Chinese did not depreciate the yuan, but instead let its value fall. The Chinese central bank had been supporting the yuan keeping it from weakening as a result of the US tariffs and slowing Chinese economy. However, allowing the yuan to decline is one way for China to retaliate against the tariffs, but weaponizing its currency increases the risks.

The US responded by labeling China a currency manipulator. Under the designation, the Treasury Department will work with the IMF to eliminate any advantage gained from the devaluation. Officially, the two sides must negotiate how to correct the situation. Only after a year of no progress, could China face any possible sanctions. So, for the most part, the designation is mostly symbolic, with the potential penalties less punitive than the current tariffs.

While the US and China planned to conduct further trade negotiations in September, an actual meeting is now in doubt.

The escalation led to a sharp sell-off on Monday, followed by a recovery on Tuesday as China took actions to keep the yuan from falling further. However, volatile swings continued through the rest of the week, through Tuesday as trade fears were exacerbated by intensified protests in China and a delayed decision on sanctions against Chinese telecomm equipment company, Huawei Technologies.

Because US and China’s goals vary considerably, we do not expect a quick resolution. As a result, we think volatility will remained heightened. Risks for global growth continue to grow, as the trade dispute between the two largest economies escalate. Trade competition is not the only issue fueling tension. The strategic interests of the US and China differ. Because of the effect our interdependence has on global markets, over the coming months, through series of 5 minute videos, we will take a look at how our differences impact our relationship.

 

Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.

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