Investors await China's response

18 September, 2018

U.S. President Trump moved forward with imposing 10% tariffs on $200 billion of Chinese imports effective next week. Trump’s move has obviously taken the trade war with China to a new level, and the confrontation may last longer than what was previously thought. There’s no doubt that China’s economy will begin feeling the pain given that the U.S. duties now cover almost half of its imports. So, expect to start seeing more aggressive monetary and fiscal actions to reduce the ongoing impact of the trade war. However, it remains unclear to what extent the U.S. economy will be hurt with these tariffs, but definitely corporate and consumer bills will be on the rise in the coming months.

Interestingly the impact on financial markets was muted after the announcement. While China’s major indices were slightly lower, stocks in Korea and Japan traded in green territory. It seems as if the latest tariff announcement was largely priced in, but what remains uncertain is how Beijing policymakers will respond. While China cannot match the U.S. tariffs dollar for dollar given the huge trade imbalance, it still has other weapons it could use, including boycotting U.S. products, increasing taxes on earnings of U.S. companies in China, refusing to grant approvals for M&A involving U.S. businesses, and reduce its U.S. debt holdings. Chinese officials have also threatened to walk away from the negotiating table, as they seem to be betting on Republicans losing the midterm elections in November. Investors should be prepared for more short-term downside risks across equity markets given all these uncertainties.

There are also little movements in FX markets as traders remained on the sidelines. The dollar index was treading water after dropping 0.45% on Monday. However, expect the greenback to resume its uptrend if risk aversion dominates again.

Sterling was the best performing currency on Monday, rising to a six-week high against the dollar to trade above 1.3150. Despite no significant progress occurring in Brexit talks, it seems traders are optimistic that a deal will be struck in the coming days. If EU leaders continue to adopt a flexible approach during their talks this week, expect the pound to continue outperforming. However, risks remain within UK politics and that could lead to big swings in the coming weeks. 


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