The trade turbulence between US and China

THE ongoing US-China trade tension may disturb the typical summer lull, while disappointing Chinese activity data (Monday) should remind investors that the current trade dispute is occurring when the Chinese economy is already slowing.

The earlier-than-expected US proposal of a 10 per cent tariff on an additional US$200 billion of Chinese imports raises the chance that this previously noted risk becomes imminent (as early as September), reducing Chinese GDP growth forecasts by 0.2pp and 0.1pp this year and next, respectively, without allowing for second round effects or further escalation.

Given the smaller size of China’s US imports (US$155 billion in 2017), retaliatory action – should it occur – might include larger tariffs but could also include a variety of non-tariff measures including guiding state-owned enterprises away from US products and services.

The Chinese yuan weakness achieved through higher US dollar-Chinese yuan fixings, while consistent with the People’s Bank of China’s (PBoC) easing bias, remains an unlikely retaliatory tool given the ongoing risk of capital outflow, in our view.

A so-far-restrained response from China has helped stabilise sentiments toward the end of the week, but we remain cautious on the local market assets of countries that are exposed to these escalating trade tensions.

Emerging markets (EM) in Asia are most vulnerable to an escalation in US-China trade tensions, particularly, Taiwan, Malaysia, Korea, and Singapore along with China itself.

To help differentiate this large group, we are most cautious on those where currencies are trading above their long-term average, equities look expensive, bond risk premia is low and indicators of positioning suggest room for further currency weakness.

India, Singapore, Australia, New Zealand, and China look more vulnerable, on this basis.

While India doesn’t have the same direct exposure to ChinaUS trade as other EM economies, it is reliant on global fundings.

Concerns about the escalating trade conflict supported the dollar, following the earlier-thanexpected publication of the list of US$200 billion worth of Chinese goods that could be subject to new tariffs.

Even traditional safe havens, such as the Japanese yen and Swiss francs, which usually would benefit from global riskoff, suffered losses compared with the US dollar.

Positive momentum for the dollar is likely to continue this week as China evaluates its response to the latest US escalation, which could include tit-for-tat retaliation or a more controlled response.