Submitted by Bilal Hafeez of Nomura
Cold War Redux
It is hard not to notice the increasingly hostile turn US and China relations have taken of late. President Trump’s UN speech accused China of meddling in US election, last Thursday Vice President Pence’s speech on the major threat of China to US security and a day later the US Department of Defence released its Assessment Report on strengthening the military with significant mentions of China. The report also incorporated China’s industrial policy as a security threat to the US. The increase in rhetoric suggests that China-US trade and FX policies will likely come under particular focus in coming weeks and months.
Yesterday, US officials expressed concerns over the weak yuan given its fall over the summer and next week will see the US Treasury publish its FX report which could label China as a currency manipulator. Meanwhile, the US trade balance with China has continued to worsen – in fact, it was fallen its largest deficit in history under the President Trump administration.
One little noticed, but important, aspect of the recent update of NAFTA was the introduction of a “poison pill” clause. This would allow the US to quit the updated NAFTA deal if either Canada or Mexico enter a free trade deal with a non-market country like China. US Secretary of Commerce, Wilbur Ross, suggested this could be added to other deals: ““People can come to understand that this is one of [our] prerequisites to make a deal”. Whether this feature in US negotiations with the EU and Japan – only time will tell, but it does imply that the target of trade deals is China more than any other nation.
Further weakness in CNY could then be seen as an escalation of the trade war between the US and China. At the same time, it would seem that CNY appears to be tracking gold closer than any other currency market. Whether this is a ploy to increase the credibility of the CNY by linking it to a credible anchor (perhaps to help internationalization) or just spurious is unclear, but it is worth monitoring.
Finally, the ultimate tool China could deploy against US tariffs and threats would be to sell part of its US Treasury holdings. It currently holds over $1.5 trillion of US Treasuries and notes. It’s previous large-scale selling was in 2015-16 was more a response to capital outflows than a pro-active policy to reduce holdings. Needless to say that would add upward pressure to US yields.