August 08, 2019

Prolonged U.S.-China Trade Talks Make Us Re-Think Trade

U.S.-China trade talks reopened last week in Shanghai for the first time since June. After negotiations stalled, President Trump suddenly tweeted his intention to slap another 10 percent tariff on $300 billion in Chinese goods. Chinese officials announced that they will halt purchases of U.S. agricultural products, while the People's Bank of China set the Chinese yuan close to 2 percent weaker, allowing it to trade below 7.00 (meaning one U.S. dollar now buys more than 7 yuan) for the first time in a decade. As a result, the U.S. Treasury dubbed China a currency manipulator.

As tensions escalated, so did risk aversion. Global stocks took a big hit and bond yields quickly declined, in sync with the conventional market reaction to ''risk-off,'' where investors' appetite for risk wanes. In a reflection of the confusion, however, some investors actually felt more comfortable putting their money into less conventional asset classes such as precious metal (gold and silver) and even cryptocurrencies, as if those were safer!

Central banks elsewhere were also quick to respond with immediate and unconventional rate cuts. On Wednesday, the Reserve Bank of New Zealand cut its key rate by 50 basis points instead of 25 basis points, resulting in the New Zealand dollar tumbling more than 1 percent in one day. The same day, the Reserve Bank of India also made an unconventional rate cut of 35 basis points, larger than the 25 expected, stating that a smaller cut was insufficient. And the Bank of Thailand also surprised the market with an unexpected cut of 25 basis points, the first in four years. Pressure is expected to mount on the U.S. Federal Reserve, too, though Chair Jerome Powell has expressed willingness to be flexible on rate cuts.

On the currency market, emerging market currencies raced to the bottom. Latin American and South East Asian currencies fell by 2.5 – 4.5 percent this week, more than the percentage drop in the Chinese yuan. Every country wants to have a weaker currency because the quickest way to get out of a recession is to export your way out, as the foreign exchange market will immediately impact prices. In turn, money went into safe-haven currencies such as the Swiss franc and Japanese yen, not the U.S. dollar.

Our View: Clearly, when the two biggest nations in the world are butting heads, the negative ripple effect on the rest of the world cannot be ignored.

Unfortunately, it doesn't seem like trade talks will move forward anytime soon. It is more important for China's President Xi Jinping to be the ''strong leader'' now, especially ahead of the 70th anniversary celebration of the People's Republic of China on Oct. 1. They don't want to give in too easily. China said it takes a ''long-term'' approach to trade talks. They may prolong the discussions until the 2020 U.S. presidential election.

Brexit took 3 1/2 years and they still cannot come to a resolution. U.S.-China trade talks may take a year and a half, or even longer. But there is a clear trend now. We have entered into a new era where we have to seriously re-think “trade" – what is free and fair trade and how that impacts both industries and workers.

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