High noon for China-US trade talks

High noon for China-US trade talks
Philip Wee, Eugene Leow10 May 2019
    Photo credit: AFP Photo

    FX: High noon for China-US trade talks

    There has been no panic selling in the currency markets over the imminent threat that US tariffs may, at noon SGT today, increase to 25% from 10% on USD200bn worth of Chinese goods into the US. There has in fact been a partial short-covering of USD/CNY that perhaps reflects expectations of lower tariffs on a last moment trade deal. USD/CNY has held near the 6.80 on hopes of averting a full-blown trade war. Consensus has given a low probability for a deal or a total collapse in negotiations today. Negotiations are expected to continue, either with or without higher US tariffs.

    USD/CNY is expected to return to 6.90 if the Trump administration proceeds to lift US tariffs. The worst-case scenario, based on our analysis of the effective link between US tariffs and the CNY, could lift USD/CNY above 7. The resulting spillover into Emerging Asian currencies would be considerable. Other than the USD, market participants could also seek safety in the Japanese yen. The Emerging Asian countries that send around 40% of their exports to the US and China are Taiwan, South Korea, and Vietnam.

    Rates: USTs getting expensive

    The market have had a difficult time digesting the myriad of possibilities that opened up the moment Trump threatened additional tariffs on Chinese imports. Just last week, a China-US trade deal looked like a foregone conclusion and the market was priced accordingly. While a last-minute deal is still a possible, the market has to factor in other scenarios (no deal and tariffs go up, the possibility of a delayed deal), however, none of them is as good as what market participants were expecting (a deal by this week).

    The reaction in US and Chinese markets have been relatively orderly compared to what we saw in 4Q last year. The S&P 500 is down by barely 2.5% from last week’s close while 10Y UST yields are down by 7bps. The reactions are more sizable in the Chinese markets with the Shanghai Composite down by over 7% and 10Y govvie yields lower by 10bps. Clearly, things could get worse if the tariffs hit and there are zero positive news flow on further trade negotiations.

    We note that the global economy appears to be in a better spot (tentative signs of stabilization in China and generally supportive monetary policy stances) compared to late last year. Financial conditions are still benign and US data has stayed firm. Accordingly, US Treasuries look expensive at current levels. To be sure, there would be further yield downside if trade talks unravel, but with the market already pricing in 1-2 cuts by end-2020, it would take a sizable shock to drive the Fed to ease even more aggressively. Reaching for duration makes little sense and we reiterate that the front of the curve (<1Y) may be the safest bet at this point.

    Philip Wee

    FX Strategist - G3 & Asia

    Eugene Leow

    Rates Strategist - G3 & Asia

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