Things are unraveling, it would appear.
Just hours after Donald Trump threatened to end a months-long truce with Beijing by more than doubling the tariff rate on $200 billion in Chinese goods come Friday, the Wall Street Journal reported that China is now considering canceling this week’s planned talks.
According to the Journal’s source, Trump’s broadside surprised Beijing, prompting officials to consider calling off negotiations.
The initial knee-jerk across US equity futures and FX markets was beginning to fade, but as the Journal’s headlines crossed the tape, the risk-off moves appeared to accelerate anew, especially in the offshore yuan, which took a fresh leg lower.
Although this could change, the yuan is on track for the largest full-day move versus the dollar since the 2015 devaluation:
“The early FX moves… are ‘real,’ with China-centric risk proxy AUDJPY -1.2% [but] the key one of course is offshore Yuan which has gapped from 6.735 Friday’s close to ~6.786 last, tied for largest 1-day jump since last August”, Nomura’s Charlie McElligott wrote around 6:00 PM ET, adding that “market forces [are] anticipating that China may allow the Yuan to weaken considerably if they choose to retaliate (a big ‘IF’), following their prior perceived ‘goodwill’ controlling of the exchange rate within a tight band the past three months for trade negotiation purposes.”
In other words, that eerie calm in the yuan (which recently took a back seat to moves in Chinese equities and bonds) could be over if the market decides to push the currency lower in anticipation of i) possible weaponizing of RMB to send Trump a message and ii) the presumed deleterious effect of new tariffs on China’s economy, where the word “stabilization” is still generally accompanied by adjectives like “nascent” and “fragile”.
Later, the PBoC announced targeted RRR cuts aimed at mid- and small-sized banks in an apparent effort to boost lending to local economies. The cuts will take effect on May 15 and should free up some 280 billion yuan (roughly $41 billion) in liquidity. On any other day, that would have likely given risk appetite a boost, but the announcement was overshadowed by the trade news.
Don’t forget, the fear of 25% tariffs on $200 billion in Chinese goods from January 1 was part and parcel of the global slowdown in Q4. If everyone starts to get the idea that we’re in for another protracted offensive by the Trump administration, it could affect expectations and start to weigh on activity data across Asia relatively quickly.
“We suspect that the most important reason for weak Asian data [in Q4] was the worry by businesses that a January 1 increase in US tariffs on Chinese exports would lead to a major growth shock”, Credit Suisse wrote last month.
The bank distinguished “fear” from any actual, real impact of trade restrictions. To wit, from a note we profiled in “The Only Thing To Fear Is (Tariff) Fear Itself“:
Very poor equity market performance in Q4 and concurrent growth weakness signaled the costs of tariff fears. Political leaders saw that the short-term pain associated with expected tariffs might be reason enough to avoid escalation. The activity that might be lost over time upon the implementation of tariffs is a separate issue from the immediate negative impulse that comes from tariff fears. This was a momentum shock, not a structural slowdown in growth due to a scale back of trade. The distinction will remain important as further tariff controversies flare in the years (or months?) ahead.
Sunday’s shrill rhetoric from Trump suggests another “momentum” shock could occur sometime soon if there’s not an effort to walk back the president’s renewed threats. This could be particularly pernicious at a time when the global economy is just now starting to pull itself up off the proverbial mat.
Another worry is that tensions will cause the dollar to rise further at a time when the greenback’s resiliency in the face of Fed dovishness is menacing emerging markets, which have (mercifully) held up ok so far, despite idiosyncratic flareups in Argentina and Turkey. Any more dollar strength, though, could be a bridge too far.
“I expect USD to gap meaningfully higher again as well after last week’s pullback, with recent ‘Dollar Liquidity’ / ‘Dollar Shortage’ concerns potentially growing exacerbated again and thus leaning into EMFX”, Nomura’s McElligott went on to muse, in his Sunday evening note.
“One lingering risk has been the recent USD strength that needs to be watched [and] one should also keep in mind that there is some (albeit small) risk that the trade deal does not materialize”, JPMorgan’s Marko Kolanovic wrote last week, while laying out the risks to his otherwise bullish view. He continued as follows:
Strong numbers in China and the US market at all-time highs remove some of the urgency for both sides to sign a deal. If there is such an idiosyncratic event (e.g. Trump abruptly walking away from the deal, or escalation with Iran causing Hormuz disruptions, etc.), systematic investors would also commence selling equities.
Marko’s base case is still that a deal is ultimately signed, but you get the point. Nothing is a sure bet with Trump.
On the “bright” side, one supposes any material, lasting escalation could push the Fed toward easing, and if the market starts to expect that, you might well see a front-end rally, especially if this week’s CPI print in the US comes in cooler than expected.