Another stress point in trade war; a steeper UST curve?

Trade war escalated yet again. EM Asia FX under pressure. UST curve to steepen.
Philip Wee, Eugene Leow26 Aug 2019
    Photo credit: AFP Photo

    FX: China-US trade tensions worsen

    Emerging Asian currencies are expected to come under pressure from another re-escalation in China-US trade tensions. US President Trump retaliated to China’s decision to increase tariffs on USD75bn of US goods. Apart from ordering US companies to exit China, Trump announced that from October 1, tariffs would increase to 30% from 25% on USD250bn of Chinese goods, and to 15% from 10% on the remaining USD300bn. These increases will be on top of the 10% tariffs on USD300bn of Chinese goods coming on September 1. The 5% increase on the USD250bn tells us that the tariff war could carry on for some time. Apart from naming China a currency manipulator, Trump’s election campaign pledge was to lift import tariffs to 45% on China.

    According to our tariff calculator, Trump’s new tariffs on September and October could lift USDCNY to 7.40 and 7.80 respectively. Between this morning and last Friday, the offshore CNH has depreciated to 7.17 from 7.13, and the offshore 12M NDF outright towards 7.24 from 7.20. Export-led currencies such as the South Korean won and the Singapore dollar were the first to feel the negative spill-over effects. Our target of 1250 represents a new and higher trading range of 1200-1300 for USDKRW. The SGD remains on track to weaken to 1.40 by end-3Q19 before easing to 1.42 by end-year. The Australian dollar has broken below its month-long range between 0.675 and 0.680; our target remains for it to fall into a lower 0.60-0.65 range. The Japanese yen strengthened briefly past 105 on safe-haven flows. The Thai baht is also at risk of resuming its appreciation if the US 10Y-2Y bond yield curve inverts.

    Rates: A steeper UST curve to navigate trade war

    The ongoing China-US trade war ratcheted up another few notches since Friday, driving US yields lower across the board. The deterioration in risk sentiment will spill into Asia as investors try to price in the worsening trade war. It can probably be assumed that tit-for-tat will be the default strategy (which means more negative headlines for sentiment) in the coming months and reinforces the point that this conflict will probably last for an extended period. On a side note, the trade war overshadows Fed speak at Jackson Hole. In any case, we can probably assume that the Fed will ease further amid heightened uncertainties.

    10Y and 30Y US Treasury yields are now below 1.50% and 2.0% respectively. The default reaction to any worsening in trade tensions is to buy Treasuries and that has worked out well over the past few quarters. While USTs look expensive relative to fundamentals, the dicey outlook suggests that prices will be supported (see here). Curve steepening (1Y/10Y, 1Y/30Y) is probably the best way to navigate the environment. The urgency for the Fed to ease will probably build after the trade war escalation over the weekend. Moreover, we do not subscribe to the view that longer-term USTs are a buy at any level. If the outlook worsens, we suspect that fiscal policy will start to play a larger role in driving 10Y and 30Y underperformance.

    Philip Wee

    FX Strategist - G3 & Asia

    Eugene Leow

    Rates Strategist - G3 & Asia

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