What happened? US President Donald Trump on Sunday ratcheted up trade pressure on Beijing, threatening by tweet to increase existing imports tariffs on Chinese goods to 25% from 10%, and to levy an additional 25% tariff on another USD 325bn worth of Chinese imports. The renewed threat comes after months of incrementally positive signals on trade negotiations, with official comments and media reports characterizing talks as steadily progressing toward a settlement.
Chinese risk assets sold off sharply on Monday. The onshore CSI 300 slumped 5.8% in its worst single-day decline since February 2016, with technology and telecom sectors leading the way lower. The offshore Hang Seng index closed down 2.9%, and the Chinese yuan has shed 0.5% against the US dollar, testing levels not seen since January. S&P 500 e-mini futures are pricing in a 1.8% decline for the US open, while WTI crude futures have fallen 1.2%. Traditional safe-haven assets have seen modest support, with the yen gaining 0.3% against the dollar and the spot gold price up 0.2%.
What triggered it? It remains unclear what led Trump to harden his stance on trade talks, with media reports suggesting it was designed to “send a message” or was in response to China backtracking on previously negotiated points. The timing of the threat suggests it is a tactic targeted at increasing leverage going into final trade negotiations.
Top Chinese negotiator Vice Premier Liu He was slated to lead a 100-strong trade delegation to Washington on Wednesday, with earlier reports suggesting the two sides had aimed to finalize an agreement by Friday. It is unclear whether Liu will travel, with the SCMP reporting China may either cancel his trip or shorten it to just one day. Last September, the vice premier canceled a trade trip in response to the US holding a “knife to China’s neck,” as one senior Chinese official then characterized it.
What next? As of early Monday, Chinese officials have remained largely silent, suggesting they are dealing with this through diplomatic channels instead of litigating the case via the media. We don’t believe the White House’s intent was to derail talks, and we would expect senior US officials on Monday to clarify the president’s remarks in a bid to keep China at the negotiating table.
That said, we have continued to warn that US-China talks could still break down, and have ascribed a 30% probability to this risk scenario. If this latest exchange were to halt progress and create a series of escalating tariffs as we head into the US election season, it could lead to further declines for global risk assets. Under this risk case scenario, the downside risk reaction would be asymmetrical; renewed tariffs and other retaliatory measures could lead to a 5% contraction in US earnings, which coupled with falling valuations could result in a 10–15% decline in US equities. Chinese equities could also fall between 15% and 20%, while USDCNY may break above 7.0. However, we are not there yet.
Heightened risk sensitivity among Asian equities isn’t necessarily surprising, with markets steadily pricing in both a benign trade outcome and more supportive policy from both China and the US. China has also just returned from an extended public holiday, with Monday the first opportunity for trade after lukewarm PMI data last week. Since their January lows, Asian equities (as represented by the MSCI AxJ Index) have re-rated by around 15% from recent lows on a price-to-book basis. Despite this improvement, they remain below their 10-year average and 17% off from last year’s peak levels.
The bottom line Our base case remains for a negotiated trade settlement, including select US tariff rollbacks in exchange for some Chinese concessions. If this were to eventually materialize, Monday’s pullback in valuations could represent a buying opportunity. We maintain a moderate risk-on stance with select relative value trades and countercyclicals to navigate heightened volatility. For investors who can, we also suggest directly hedging a small portion of equity exposure. Within our Asia portfolios, we hold our overweight on MSCI AxJ equities with a collar option for downside protection and remain overweight on offshore Chinese equities.
For more region-specific ideas on how to prepare for downside and stay positioned to capture upside, please read our report, "Be prepared: Plan, Protect, and Grow."
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