The US-China trade war escalated further overnight with news reports that the Chinese government has requested state-owned companies to suspend imports of US agricultural products. This appears to be in retaliation to Trump’s proposal to add 10 per cent tariffs on another USD 300 billion of Chinese imports which was announced on Thursday last week.
US Treasuries surged with the long bond now up over 5 points since the end of July (at the time of writing) and stock markets have taken another tumble declining around 1-2% so far this morning.
A more worrying sign is the Renminbi breaking through the psychologically important level of 7 against the US dollar. Earlier in the trade negotiations, it seemed as if there was a tacit understanding between the two sides that the Renminbi would remain stable. That would have been a key demand of Trump who has attacked not just the Chinese, but also Europe and Japan, for using exchange rates to gain an unfair advantage. Unless the PBoC acts decisively to prevent further weakness (interest rates in China were not lowered with the US btw) then the knock-on impact will be far broader than just dollar/renminbi.
This is shaping up to be a classic flight to quality move with the Yen gaining and the indebted nations (Australia, New Zealand, Brazil, Indonesia for example) seeing currency weakness. As it is hard to see how this trade war ends, if it ends at all, the conclusion one has to draw is that global growth will take another hit. Bond markets are signalling significant economic problems ahead, with the only saving grace being that the Fed has room to cut rates further. However, the world economy is like a supertanker and it takes a long time to turn things around. So, even if the Fed were to ease aggressively from here, it may already be too late to avoid a recession. Events may unfold in an unexpected way, but at the moment it looks highly likely that the US will be dragged into recession within 12-18 months, along with many export-led economies which are already showing signs of significant economic strain.