China-US Tariff wars take another twist

Global markets have taken a beating in the past two sessions led by fresh developments in China-US trade wars. Until now, China had been angling towards a strategy of slow-rolling the US on the trade war. That changed after Trump shocked the world last week by announcing a fresh round of tariffs to take effect Sept 1. China hit back on US tariffs Monday in a sign of a change in tactics in the trade war that has deep consequences.

China allowed the yuan to weaken below the key 7.00 mark on Monday in the onshore and offshore market. Reports of cancelled agricultural purchases also roiled markets. Dollar Index posted its biggest decline since June 4th,  US 10-year yields fell 10 basis points to 1.73% and the German bund fell to -0.52%. The S&P 500 fell ~3%, the biggest daily drop since December 2018 and the German DAX broke the 200-day moving average. Gold has exploded to a fresh cycle high, hitting a high of $1478.

This morning, the Yuan fixing was a little lower at ~6.96 providing some relief to the battered equity markets. But things are changing rapidly as the hedge funds are increasing chances of Fed rate cut with September being the done deal. Market is going even one step further to price in 50 bps rate cut with a probability as high as 39%. Meanwhile, Both Trump and Munchin have not backed away in labelling China as currency manipulator again, which is nothing new but needs to be seen in the context of 2015 risk aversion when Yuan was devalued overnight.

China can slap limited tariffs back and it can't afford to sell large amount of US treasury holdings. Best way to counter these tariffs is to devalue Yuan in a controlled fashion.This way Trump will be roiled and China will make money on treasury holdings as Yields plunge further. Already Trump-Fed have set up horror dynamics with Fed independence now being questions by ex-Fed chairpersons. With US elections set in Nov 2020, China has a chance of turning farmers and retailers against Trump and a chance to get better deal post election in case he is not elected back to the office. 

This devaluation is expected to be far more controlled sending Gold higher and USD down across the board unlike 2015 where Yuan fell along with Gold and Dollar went higher against all currencies (except the safe heaven Yen). The game of cat and mouse has just begun!

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