Trade talks between the US and China are set to resume this week. The conditions are anything but ideal.
Thanks to Donald Trump’s extraordinarily ill-advised decision to openly solicit election interference from Xi Jinping last week, it’s reasonable to assume that Liu He and his entire delegation were warned by the Party leadership in Beijing that anything said in Washington is subject to being subpoenaed by House Democrats.
In addition to that, the threat of the administration moving forward with proposals to limit capital flows and the October 15 deadline beyond which 25% tariffs on $250 billion in Chinese goods are scheduled to ratchet higher to 30%, loom large.
On Tuesday, we cited Goldman in detailing the flow implications of some of the options reportedly being weighed by the administration to cut off US investment to China. In a note dated Thursday, the bank expanded a bit on their initial analysis.
“On the narrow issue of whether or not the US could restrict portfolio flows to China, the answer is yes”, the bank writes, adding that “this would likely need to come through a combination of political pressure and passing existing, pending legislation, but it is ultimately about changing rules or practices of US government agencies (albeit independent ones)”.
As to whether the actual pool of capital matters in the grand scheme of things, restricting government pension fund involvement in Chinese assets would have a “fairly limited” effect, the bank notes, before cautioning that a move to delist Chinese shares from US exchanges – which Treasury says isn’t imminent – would be more consequential.
Beyond that, Goldman makes an important observation. “If the Administration chose to take a more severe line than what is reportedly being discussed now, both channels could potentially be widened to include other pools of US capital, such as by pressuring state and local pensions or applying similar rules to Yankee bond markets”, the bank cautions. Given Trump’s penchant for taking things to extremes, that pseudo-warning from Goldman is worth a mention.
More immediately, the problem with the capital flow restrictions story is that were it to be realized, it would represent an as yet unpriced escalation.
“Financial markets have grown somewhat accustomed to, and efficient at, pricing the probability of tariffs, but, with the US soon to have implemented tariffs on almost all of its goods imports from China, and the trade war’s impact on global demand starting to hit US shores, market participants increasingly expect that trade tensions should start to level off”, Goldman goes on to write. Those expectations would be shattered in the event the Trump administration betrayed a willingness to pursue other avenues for pressuring Beijing beyond the widely discussed tariff and non-tariff barriers.
Meanwhile, Goldman warns that “even some of the smaller steps that are reportedly under consideration could have a significant effect relative to what [the] simple flow metrics would imply”. By that, the bank means that curtailing capital flows risks crumbling one key pillar of support for the yuan, thereby putting more downward pressure on the currency at a delicate juncture.
“USDCNH vol-adjusted skew is higher compared to previous rounds of talks, indicating that CNH markets may be less optimistic this time around”, Barclays said over the weekend, adding that “in case of a partial deal, in which tariffs scheduled for October 15 are delayed, we expect a shallow near-term dip in USDCNH towards 7.0”.
Chinese markets are set to reopen on Tuesday following the holiday and eyes will be on the daily fixes. “CNY fixings have not been following the model estimates since early August, likely becoming more managed going into the October round of trade talks, where the CNY and the currency manipulator designation by the US Treasury are expected to be topics of discussion”, Barclays goes on to say, noting that “a similar episode occurred in May—June going into the June round of talks, where fixings were held stable at 6.90”.
Of course, it’s possible that the deceleration evident in the US economy and Trump’s domestic political woes will compel the administration to seek some manner of short-term deal, interim agreement or detente in order to engineer a market rally.
Whatever the case, the trade talks will demand investor attention in the week ahead and thanks to Trump’s exhortations for China to investigate the Bidens, the already fraught negotiations are now intertwined with the impeachment inquiry.
For his part, staunch Trump ally Jim Jordan says the president was just kidding.
“I don’t think he really meant ‘go investigate'”, Jordan said over the weekend. “[Nobody] really believes that the president of the United States thinks China’s going to investigate [Joe Biden]”.
File that away for posterity, folks.