May 09, 2019

What are Markets Really Saying About China?

This week, it was impossible to see the amount of red ink coming from U.S. equities and not feel like there are big problems around the renewed potential of tariffs on China and the resulting increase in trade tensions.

U.S. equities fell about 3 percent in the first half of the week while Chinese stock indices fell 5 to 7 percent. Even so, markets are not unanimous in their reaction to these news developments.

One notable exception is the Chinese yuan, which is off by less than 1 percent. Granted, the currency is heavily controlled by the government, but some currency analysis shows that the yuan should be weaker by more than this on the news. On this front, China is trying to maintain currency stability and not roil markets.

Other examples of markets differing in their reaction are evident in the currencies of the countries that supply China with raw materials. Currencies such as the Australian dollar, New Zealand dollar and Chilean peso have hardly moved this week.

In addition to the currencies themselves, we see little movement in the derivatives markets, where market action indicates more specifically what kind of volatility traders expect when it comes to future activity. The JP Morgan Global FX Volatility Index has barely moved even as the more commonly known Cboe Volatility Index (VIX) has surged this week.

 JP Morgan Global FX Volatility Index

How do we interpret this? It seems like some key parts of the affected markets are not going too crazy on this, but their reaction begs the question of whether those folks really think there will be a deal. Or will there be a new global trade paradigm? Or do these markets not even know what to think?

Our View: Markets are adjusting to one of two possibilities. Either a significantly changed U.S. trading relationship with China or a significant shift away from trading with China. Already this week we have been hearing about companies broadening their supply chain with a “China plus one" approach, sourcing relationships in China as well as factory contracts in other countries that are able to ramp up production as tensions rise.

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