US stocks are squarely on the back foot again, and that’s thanks in no small part to Friday’s news that the Trump administration is mulling a series of options to restrict capital flows to China.
Those proposals include, but are apparently not limited to, delisting Chinese equities from US exchanges, compelling US firms to limit inclusion in indexes and capping investment via government pension funds.
The news has the potential to infuriate Beijing, especially as it hit just ahead of a politically-sensitive holiday and less than two weeks before the the next round of trade talks between Vice Premier Liu He, Bob Lighthizer and Steve Mnuchin. “This story pretty much came out of nowhere and the timing is terrible”, Oanda’s Ed Moya remarked
Stocks dove when the news crossed. By the closing bell, US equities had logged their second consecutive weekly loss. The red highlights in the top pane denote the weekly losing streaks associated with the resumption of trade tensions in May and August.
In the bottom pane is Alibaba, which had its second-worst day of the year on Friday thanks to the capital flow restriction news.
One reason the broad market didn’t react more violently may be that the idea is wholly absurd, even as it does have some traction on Capitol Hill. “Delisting Chinese companies would be disastrous for the US economy and we should not see the market take this threat too seriously”, Oanda went on say, adding that “the limitation of American pension funds access to Chinese markets would see massive portfolio swings that spells disaster for the tech sector”.
The yuan fell to a three-week low on the news, which came during the same week that FTSE Russell took a pass on including Chinese bonds in their World Government Bond Index, potentially robbing China of some $130 billion in inflows over the phase-in period (roughly $6-8 billion per month). Chinese bonds have, of course, won inclusion to the Bloomberg Global Aggregate index and the JPM GBI-EM Global Diversified index.
“We maintain our near-term target of 7.20 for USD/CNY in light of renewed uncertainty around portfolio flows and our expectation that the US will raise tariff rates as scheduled on October 15”, Goldman said Friday evening.
Commenting on the capital restrictions story, the bank noted that although this discussion is “not entirely new” it very well could “refocus market attention on this aspect of the bilateral dispute”.
According to Treasury’s TIC data, US residents held nearly $192 billion in Chinese equities at the end of June, the latest date for which data is available. Ownership of Chinese bonds has accelerated, hitting roughly $12 billion this summer.
EPFR data shows US-domiciled mutual funds hold around $280 billion in Chinese assets, the majority of which are stocks.
Other analyst reactions to the news ranged from the incredulous to the outright dismissive. “This is not little stuff. This is huge”, a San-Francisco based wealth management firm told Bloomberg. “This one is a non-starter”, one strategist at Columbia Threadneedle remarked, while Deutsche’s Alan Ruskin called the headlines “not a great sign on the state of the trade negotiations”.