It’s entirely possible we’ll all look back on Monday as nothing more than a ham-handed attempt on the part of Donald Trump to send a message to Beijing at a time when China appears to be slow-playing things during the final stretch of trade negotiations.
Nobody ever accused Trump of being subtle and he’s never completely come to terms with the fact that “the art of the deal” needs to be conducted differently when there’s more at stake than a real estate project. China is by now accustomed to the president’s penchant for doing and saying things that are objectively irrational in the pursuit of “wins”, so it’s not out of the question that Xi will shrug this off as just another manifestation of the US administration’s unorthodox approach to foreign affairs.
All of that said, it’s never been clear that trying to corner China in the pursuit of quick “victories” is a viable strategy. Beijing rode out the storm in 2018 and in the new year, stimulus is arguably starting to work its way through to the real economy, potentially reducing China’s incentive to agree to further concessions. If you consider that Beijing was already keen on letting some steam come off the Mainland equities tea kettle, a shallow selloff in domestic stocks might not be viewed as an unequivocally negative development as long as the vaunted “national team” can prevent an outright rout.
The point: Bending the knee to Trump might be seen as not only unpalatable, but as unnecessary at the current juncture.
“In the context of intensive bilateral negotiations, we believe this is likely a part of the US’ tactics to get the final deal done, rather than a deliberate and decisive plan to escalate the trade tension into a war”, BofAML writes on Monday, before effectively reiterating the old adage about “the best-laid plans”. To wit:
While that may well be the plan, it leaves China in a difficult position not to respond with a firm stance. President Xi Jinping has won more credit lately by promoting the ongoing trade negotiations as part of the overall opening-up plan for the country. However, if the high-profile potential tariff hike materializes in a few days, Chinese policy makers will have to come up with some form of counteraction to avoid losing policy credibility at home.
The bank goes on to present three near-term scenarios, one bull, one base, and one bear.
In the bull scenario, policymakers on both sides determine that it would be foolish to waste nearly a year’s worth of effort and risk a financial market meltdown. “In the case of very significant reactions in the global financial markets, the US and China’s top decision makers may see renewed demand for a deal and work towards it in the coming weeks or months”, BofA says.
The bank’s base case appears (to me anyway) to be a bit less rosy than other quick takes we’ve seen on Monday. Generally speaking, consensus seems to be that this will be resolved in relatively short order, but BofA doesn’t sound so sure. Here’s their assessment of the most likely scenario:
Base – trade impasse amid uncertainty: we notice that for both President Trump and Xi, the urgency of reaching a trade deal has declined modestly in the past few months, supported by better economic growth and market performance in both countries. It implies that while ultimately a trade deal would be great news, the need to hastily reach an agreement with considerable concessions on either side is likely no longer desirable. Hence, even if the tariff hike does not materialize this week, the two sides could exchange harsh rhetoric on each other in the media and suspend official trade negotiations for a month or two, before returning to the negotiation table formally in the following quarters.
I don’t think it’s a stretch to say that were that scenario to play out, markets would be unamused. Considering how keen both sides have been on perpetuating the “progress” narrative, already jaded traders may feel a sense of betrayal and decide to play vigilante, pushing down risk assets and driving up volatility.
As far as BofA’s bear scenario, the bank notes that “in [the] most bearish case, the US tariff hike will be met with China’s retaliation in the form of tariff hikes (especially on US-made cars) and import diversion (such as buying soybeans from Brazil).” If that were to play out, the “momentum shock” (i.e., the dent to sentiment from negotiations stalling) could morph into an actual deceleration in global growth, rekindling fears of slowdown at the worst possible time.
For their part, Barclays’ base case view of a trade deal being reached is still… well, it’s still the base case. But the bank frets that the likelihood of a “worse case” scenario has now risen. Here is what that would entail for China, according to the bank:
A 25% tariff on USD200bn of China’s exports has been our ‘worse case’ scenario and would likely drag down GDP growth by 30-50bp over a period of 12 months via direct trade channels with exports down by 3-5pp (Figure 1). We estimate that an additional 25% tariff on USD325bn of goods could reduce China’s GDP growth by another 0.5%. In such a scenario, we would expect China to step up policy support, and monetary policy will likely be eased further, along with other actions such as additional RRR cuts (see below). The PBoC could tolerate more CNY depreciation and quick moves cannot be ruled out if there was a genuine breakdown of negotiations.
For now, it appears China is simply doing what everyone else is doing: Waiting to see if Trump or his surrogates try to walk back Sunday’s threats in light of the fairly violent market reaction on Monday.
So far, Trump isn’t backing down from the balderdash. If Wall Street manages to pare losses, the administration may see any resilience as a sign that the risks of an escalation are worth it.