Will The Chinese Retaliate Further?

Market Shocked by Fresh US Tariffs

The ongoing US-China trade war took another dramatic turn last week. Initially, focus had been on the fresh set of trade talks taking place in Shanghai.

Expectations were low given the previous difficulty with talks. However, there was still a level of optimism as the market expected the two sides to finally work together to end the trade war.

Trump’s Twitter Announcement

However, following the two days of talks, which ended with seemingly little-to-none progress, the market was rocked by news of fresh US tariffs on Chinese goods.

Trump announced a further 10% tariff on $300 billion worth of Chinese goods via a post on Twitter. The post read:

China Retaliates with Currency Devaluation & US Agriculture Exit

China immediately responded to the news saying that it plans to retaliate. And it seems they’ve already made their first moves.

In early trading on Monday morning, the Chinese yuan spiked sharply lower against USD. USDCNH was trading above the 7 level for the first time since the Global Financial Crisis in 2008. 

The move has been interpreted as a clear retaliation by the Chinese government against Trump. The Treasury Department, therefore, swiftly called out China for currency manipulation early on Tuesday.

Following this, the People’s Bank Of China (PBOC) helped contain the falls. The USDCNH outlook remains bullish above the 7 mark and this is likely to remain the case should the PBOC maintain a limited size of yuan longs.

China did also suspend the purchase of US agricultural products as early as Monday this week in response to Trump’s new trade war rout. China’s Commerce Ministry did this as an indication that China both can and will use other means of retaliation to hit back.

How Else Could China Retaliate & What Would The Market Impact Be?

The two retaliatory moves are likely just the first step for the Chinese.

The option we can expect the most is for a further increase in tariffs on other US goods.

However, China is likely very near the limit of how many tariff increases its own economy can withstand. Tariffs on US goods impact the turnover and profitability of domestic businesses, many of which are already suffering as a result of US tariffs. The game of tit-for-tat tariff raising is, therefore, unlikely to be sustainable for China.

In fact, should China announce tariffs of its own, global equities would be shunted further lower. So the Asian giant will no doubt be considering alternative options now.

Meanwhile, the hit to global trade has been revealed. European, Asian and UK equities have all been under pressure this week along with US and Chinese stocks.

Ban on Rare Earth Exports

Following the breakdown of talks in May and the subsequent tariffs from the US, the prospect of China banning exports of rare earths materials was raised.

These materials are used in many high tech applications and operations. And with China holding a monopoly in their supply, such a move could be devastating for US businesses. This would be especially damaging to the highly profitable US tech sector which has, so far, been relatively shielded from the impact of the trade war.

The potential damage to tech companies would likely be reflected in a sharp move lower in the NASDAQ (along with a general risk-off tone to equities).

Unreliable Entity List

Another route which we might see China taking would be to announce its own “Entity List”. This would be its own version of the one the US used to ban Huawei from dealing with US companies.

The Chinese Ministry of Commerce of China (MOFCOM) announced on May 31st, 2019 that it was drawing up a list to be announced shortly. With such a list, the Chinese government could prohibit Chinese companies from conducting business with specified US companies.

Once again, such a move would weigh heavily on US equities prices. Gold prices would likely be well supported in either instance. Safe-haven inflows are already boosting gold higher this week. The precious metal is now trading at its highest level since May 2013! This comes as investors flood to safety in light of the ongoing equities collapse.

How Will This Impact US Monetary Policy?

The Fed is certain to be watching these developments with disappointment. The central bank cited the ongoing risks from the trade war as a reason for cutting rates last month, despite downplaying the likelihood of further easing.

However, with trade tensions increasing once again, the Fed could need to ease again. This is despite the bank stating that it shouldn’t respond to trade disputes.

The course of Chinese retaliation will undoubtedly be a key factor in the impact on both the US and global economy in the coming months.

Market Impact

The reaction in US equities has been severe. The SPX500 has reversed heavily from recent highs around 3031, breaking back down below the 2958.22 level. Prices broke outside the bullish trend line from last year’s lows, with structural support sitting just beneath at 2811. A break here could pave the way for a much deeper run down to support at the 2727 level. Below there, the 2623 level stands as the next support, by which point the decline would have exceeded the 50% Fibonacci retracement of the current bull trend.