MARKETS: Heading from trade war to currency war?

Investors in Asia woke up to a sea of red in equity and currency markets on Monday. Japan and South Korea’s stock indices fell more than 2%, while Hong Kong’s equities faced an even steeper fall of more than 3% with political tensions continuing to escalate further.

Treasury bonds, Gold, and the Japanese Yen are where investors are taking refuge in what seems to be a never-ending trade dispute between the world’s two largest economies.

Markets had not been expecting the latest US-China trade talks to conclude with any significant breakthrough, but very few expected President Trump to slap 10% tariffs on $300 bln worth of Chinese goods. China’s commerce ministry vowed to retaliate with the necessary countermeasures, but no further details were announced.

China still has a few tools to respond to the latest US tariffs, whether it’s through halting imports of American agricultural products, prohibiting exports of rare-earth materials, stopping the purchase of US debt, or further increasing tariffs on US goods. However, none of these tactics are enough to offset the impact of the additional tariffs on more than $500 bln worth of Chinese goods.

Is Currency the new option?

The Renminbi broke above Rmb7 per USD Monday morning after the People’s Bank of China (PBoC) set the midpoint at 6.9225. This is the first time since May 2008 that the Chinese currency trades above the key psychological level of 7.

The PBoC has spent hundreds of billions of Dollars over the past couple of years to prevent their currency from breaching this key level, but now that doesn’t seem to be the case. In fact, the currency tool may be very effective as it significantly offsets the impact of US tariffs. If the Chinese currency falls by another 8% from the current level, the 10% tariffs paid by US importers will be offset by the Renminbi’s weakness.

While currency depreciation also has a negative effect, such as the risk of capital outflow, as long as the decline is orderly, volatility is contained, and speculation activities are controlled, the risks will be minimised.

No one knows when this trade war will end, but it is becoming more likely that it will be after the US 2020 elections. We don’t think that this trade war will do any good to President Trump in the upcoming election, especially given the several swing states that are already hurt by the current trade dispute.

Until then, expect volatility to return to global financial markets with safe haven assets to be the main beneficiaries. Out of all safe haven assets, Gold will be our favourite, especially if this trade war gets out of hand.

Source: The Financial Mirror