Recap of the day: Trade tensions between China and the US will not be resolved in the short-term
Wall Street suffered its worst loss this year on Monday, as China held firm over its tariff brawl with the US. The Chinese Foreign Ministry reaffirmed that “on principle, China won’t give an inch”, after the US imposed 10% tariffs on China’s remaining $300 billion of imports.
In response to the Trump administration’s latest move, China has halted imports of US agricultural products, whilst both offshore and onshore Chinese yuan fell sharply and broke the key 7 level’s threshold. Beijing’s even more forceful response saw the DJIA, S&P 500 and Nasdaq slump 2.9%, 3% and 3.6% respectively.
The US Treasury Department branded China a currency manipulator after the day’s trading closed, which heightened tension between the two countries. Global stock markets suffered further losses after the announcement, with the S&P 500 index futures dropping another 1.3% as of 8am in the Tokyo session. Asian stock markets all fell further at Tuesday’s open, as they tracked Wall Street’s worst sell-off of the year along with the announcement from the US. The Hang Seng Index and Shanghai Composite Index fell 2.3% and 1.58% respectively, with the latter extending its loss in the morning session.
Although the People’s Bank of China said the country won’t use forex as a tool in the trade dispute, the offshore Chinese yuan traded at the lowest point this year at 7.13’s level this morning. The dollar was further weakened to 97.20’s level while the EUR/USD surprisingly, albeit passively, surged up to 1.1250’s level.
Apart from trade dispute tensions, the US ISM reported that its non-manufacturing activity index fell from 55.1 to 53.7, which was much worse than the predicted figure of 55.5 for July. The number indicated that growth in the US services sectors decelerated in July to its weakest level in three years. As service sectors account for more than two-thirds of the US economy, investors now believe it has become even more weakened since the figure has been released.
Today’s analysis: Has the US used up almost all of its trade war weapons? Will China wait for the 2020 US Presidential election to renegotiate?
The US’s current strategy to secure a trade deal with China, especially considering its recent course of action, will certainly fail. There’s no doubt Beijing has used the Chinese yuan as a tool to lighten the influence of US tariffs in the future, but the US’s branding of China as a currency manipulator has actually had little impact on the country at all.
While China will suffer from the latest tariff and its economic condition will deteriorate this year, Beijing will be less inclined to negotiate with the US because of this latest move. The Chinese government’s stance is clear - they will not give in to blackmail or this attempt to maximise pressure, both internally and diplomatically.
But Trump’s recent actions are bad news for a trade deal, meaning an agreement between the two countries is one step further away. Tension between the two superpowers is now more intense and trust and communication has deteriorated even further. A trade deal is unlikely to be agreed on this year and China may wait till the US presidential election in 2020 to apply more pressure on Trump, given that the US has almost used up all of its trade war “weapons” to pressure Beijing.
In this case, we expect the US’s economy will deteriorate and its economic figures will weaken in the third quarter. This will put more pressure on the Fed to lower its rate, which will reaffirm our belief that the Fed is going to implement this once more this year (although it may not happen in September).
The stock market may have overreacted to the impact on China, as Beijing is tipped to manage the drawbacks of tariffs with currency rates. We still expect indices to open with a tumble but the drop will be narrower should no further action be taken from both sides. But beware of what China will do as a countermeasure - Beijing has confirmed it will release new sanctions on the US in response to its actions.
Looking at the economic calendar, the market is lacking vital figures from the US and Europe. The Reserve Bank of Australia released a policy decision this morning that disappointed the market, because it didn’t feature a more dovish policy or tone. The RBA held the benchmark cash rate unchanged at 1%, as widely expected, while AUD/USD gained after the policy decision was released.
But with Chinese yuan deflation and tightening trade war tension, AUD/USD and NZD/USD are more likely to follow the performance of the Chinese yuan in the short run, and investors may refer to the vital support level of 0.6740 for AUD/USD. It is expected that the yuan, AUD and NZD will adjust from the previous slump, while the overall trend will still be going down. Should the level be broken, AUD/USD may open a new downtrend. The dollar may continue to retreat from the sharp drop over the previous two days and reach 97.70’s level today.