The Trump Administration finally implemented the promised tariffs. However, it was not what anyone was expecting. To be sure, $200 billion of Chinese exports to the US were targeted with immediate effect, but full implementation has been delayed until January of 2019.

Trump Blinks, CSI 300 Up 6.4%

In last week’s commentary, we wrote the following:

Despite the US-Chinese trade war, we continue to believe markets have overly discounted Chinese equities. We do not see the same discount in US companies that depend on trade with China, and that makes Chinese equities relatively cheap.

After the announcement of Trump’s watered-down tariffs, the CSI 300 index rallied 6.4% last week. To allow US companies more time to tweak their supply chains, The Trump Administration applied a lower 10% tariff on $200 billion of Chinese imports, effective on the 24th of September. The previously proposed 25% levies will be delayed until January. China immediately retaliated with tariffs on $60 billion of US imports. Having priced in a 25% levy, global markets rallied on the news.

Is China Preparing to Devalue?

As the trade war escalates, it remains to be seen whether China will weaponize its yuan. China continues to defend the USD/CNY key level of 6.9. The last time the FX pair threatened that level was in January of 2017 when China was in the middle of a liquidity squeeze. Then and now, the PBOC introduced the “countercyclical factor” adjustment to blunt the depreciation of the yuan and limit the extent to which the currency is permitted to float. As the January deadline approaches for full implementation of the 25% levy, there will be less incentive for China to avoid aggravating Trump by making adjustments through the exchange rate channel.

Keep in mind that any use of foreign exchange policy as a weapon in the trade war with the US will also impact China’s other trading partners. China’s exports to the rest of the world in August were valued at $217.4. Accounting for seasonality in the data, its annual exports are estimated at $2.4 trillion. The yuan would only have to drop 0.83% to cover the impact of the 10% levy on $200 billion of Chinese exports to the US. If the 25% levy is implemented, a drop of 2.1% would offset the impact.

So, what would you expect the logical action of the Chinese government to be if devaluing the currency was on the agenda? Would it not make sense to shore up political support from its other trading partners to prepare for such an outcome?

As it turns out, the Chinese government did just that. Shortly after Trump’s decision, the Chinese Premier Li Keqiang announced plans to cut the average tariff rates on imports from China’s trading partners as soon as next month. This is a brilliant tactic on so many levels. In addition to gaining political capital with its trading partners, the Chinese response to Trump will simultaneously make US goods more expensive and the rest of the world’s cheaper to Chinese consumers.

Rates Continue to Rise

Last week we wrote about the global trends of rising inflation and rising rates. On Wednesday, Norway’s central bank joined the club and announced the first hike in interest rates in seven years. Norges Bank increased the benchmark rate by 25 bps to 0.75%.

On Wednesday, we will get our Fed decision, and most market participants are expecting dollar rates to rise. This rate hike will be mirrored by all dollar-pegged economies that follow moves made by the Fed. Hong Kong’s banks have already begun raising deposit rates in anticipation of the hike. The pressure was felt in the FX markets as the Hong Kong dollar 0.6% surge on Friday spooked carry traders. This is especially rare because the USD/HKD is a managed pair that rarely moves outside a tight trading range.

The Week Ahead

Be careful trading the off-shore trackers this week, and watch for illiquidity. We will have to wait another week to see whether the rally in Asian equities has legs. Asian trading will be limited at the beginning of the week due to the number of scheduled holidays across the region. China is on holiday to celebrate its Mid-Autumn Festival, and its exchanges will open on Wednesday. Hong Kong’s markets close on Tuesday. South Korea’s markets close from Monday to Wednesday. Japan is also closed on Monday for Autumnal Equinox Day.

The US and UK are due to release GDP figures. The FOMC meets on Wednesday to decide on rates. EU CPI figures should give us a clue on the ECB’s timetable for raising rates.



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