Donald Trump repeated his biggest threat on Tuesday that China could face tariffs on all exports to the United States if it attempts to retaliate previous rounds of tariffs. Verbal pressure gains magnitude amid growing slack in the Chinese economy which becomes increasingly hard to deny. The authorities can keep unmoved countenance in front of confirmed patriots.
Speaking with reporters in the Oval Office, Trump said that China is not ready yet to join them to the negotiation table. According to the president, the administration had to cancel meetings with the Chinese delegation several times, because the negotiators had nothing to offer.
However, it is obvious that the Chinese government will adhere to a strategy of passive resistance until November, when mid-term congressional elections are scheduled in the United States. China certainly bets on strengthening the power of the Democrats which are likely to throw off Trump’s protectionist plans, removing tariffs escalation threat and initiate the dismantling of trade barriers. Based on these rough arguments, it can be assumed that Chinese assets will continue to fall in price on signs of a cooling in economic activity, if economic data doesn’t reveal unexpected U-turn.
Chinese exports are expected to continue to slow down in September due to the contraction of orders, since the impulse of “pre-tariff” shipments has exhausted itself and now Chinese manufacturers have to cope with new, harsh conditions. In regards to import data, there is also nothing bright to expect, although the government’s bet on domestic consumption will probably keep this side of the trade balance from large losses. According to the consensus forecast, export growth rates in September will slow to 8.9% compared with 9.8% in August (annual terms), import growth will also decline and will be 15% in September against 19.9% in August. China’s trade balance is expected to fall to 19.4 billion in September, almost one and a half times compared with August.
The index of activity in the production and services sector from Caixin showed that firms without government support faced a decline in demand and were forced to endure part of the impact on workers and their wages. With the deterioration of the activity indexes, it is likely to expect an increase in employment problems, as one Chinese official recently warned. As a result, the transformation of the Chinese economy from production to consumer may drag on. The local government of Guangzhou, the largest region of GDP, reported that manufacturing activity barely increased in September, after a decline in August.
The Chinese government will also release monetary indicators today, in particular the growth rates of the main monetary aggregates (M0, M1, M2). Indicators of new loans and aggregate financing, respectively, will shed light on how things are going with the reduction of leverage in the Chinese economy. However, it is already clear that the decision of PBOC to reduce the reserve ratio by 1% increases the risk that actual data will leave forecasts behind, which will negatively affect the positions of the yuan.
Next week, the US Treasury publishes an FX report that examines the monetary policy of US trading partners. There is a high risk that China will be declared a currency manipulator and new sanctions will follow in the framework of this document. The outflow of capital from China and the pressure on the yuan against this background will probably only increase.
All of the above suggests that capital outflow from China will continue. In 2016, in the same situation, the government used one of the reserve parachutes – the US T-bills on the balance sheet. Large-scale bond sales two years ago occurred in response to capital outflows in order to find foreign currency to contain pressure on the foreign exchange market.
Now China’s treasury bond purchases have fallen to almost zero, and if one of the main US creditors starts selling bonds, there is a risk that the T-bills yield will continue to grow.
Let me remind you that the IMF has revised downward forecasts for China’s economic expansion for the next year. The GDP forecast fell from 6.4 to 6.2%.
So far, the main deal I consider is short gold due to the significant positive correlation of the yuan with the yellow metal. The chance that sentiment in the Chinese economy will make a reverse is quite small, and the warming of relations with US is in a more distant horizon.
Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.