Why The "World's Most Important Gauge" Could Create Havoc

Authored by Bloomberg's Michael Msika

Another hit. It seems every day carries some news destined to make U.S.-China trade negotiations more difficult, with the ban against Huawei the latest example. The effects of the spat have started to show on currency markets and could deliver collateral damage, and European exporters could be big losers.

The escalation of tensions has pushed China’s yuan to year-lows against the dollar, near the 7.0 level seen as critical by several strategists at JPMorgan and Nordea. Further weakness could hurt Chinese asset prices and risk appetite globally, making it “the most important gauge worldwide currently,” Nordea says, and something that European equity investors can’t ignore.

The trade confrontation could drag on, according to Sebastien Galy, a senior macro strategist at Nordea Investment Funds. The next G20 meeting (June 28-29) could be decisive, and if no deal is in sight, the market will likely speculate on a devaluation of the renminbi and higher tariffs, providing a shock to the equity market, Galy writes.

Indeed, the U.S.-China dispute is the most significant hit to the early 2019 consensus of a cyclical global recovery, JPMorgan strategists write, adding that the Chinese Central Bank has been willing to act to prevent further weakness in the yuan.

“While it seems unlikely that China will let the yuan trend lower too durably beyond the 7 threshold, it appears equally unlikely to us that they will not be tempted to do so, just for a while, to test some nerves a bit,” Makor strategist Stephane Barbier De La Serre writes. The strategist has a 7.15 target for the currency, which would have a material impact on global equities, particularly on cyclicals and tech stocks.

The yuan has also lost ground against the euro, which is bad news for European firms selling goods overseas. JPMorgan strategists closed their overweight recommendation on European exporters this week, arguing the euro could be bottoming out.