Two cars are moving towards each other on a country road, they are led by Donald Trump and Xi Jinping. Both drivers are aware of the risks, but neither wants to lose face, and each relies on the strength of the national economy.
Experts continue to wonder how far the parties can go in order to turn the trade confrontation in their favor.
The Chinese gambit
"Many investors assume that the Celestial Empire is ready to accept the slowdown of its economy and the world to prevent the election of D. Trump for a second term," said Naka Matsuzawa, chief strategist of Nomura.
"China can further reduce the import of agricultural goods from America in an attempt to undermine the position of D. Trump before the presidential elections to be held in November 2020," said UBS investment Director Mark Haefele.
The US budget is already losing a lot of money because of compensation payments to farmers, who are almost the most affected by the trade war in the country.
"Perhaps the Celestial Empire will decide to wait for the change of power in Washington. If necessary, China can respond with targeted measures to put D. Trump's election positions at risk, even if the global economy and financial markets are under attack," David Bianco of the DWS Group said.
"However, Beijing's strategy may come out sideways to him. Aggressive measures against China will be supported by both parties in the US Congress, and the next US president may take a similar position," N. Matsuzawa warns.
In addition, further deterioration of the Chinese economy can destabilize the country, which has already faced protests in Hong Kong. In the second quarter, China's GDP showed minimal growth over the past 27 years.
According to the National Bureau of Statistics of China, in July, producer prices fell by 0.3% in annual terms against the expected -0.1%. This was the first decline in the last three years.
"The dynamics of this index has a high correlation with corporate profits and signals a drop in demand for commodity assets due to the ongoing trade war between the US and China. All this is an extremely "bearish" factor for the Chinese stock market, while the possibilities of the People's Bank of China to stimulate the economy are extremely limited," said Kungwa Kim, an analyst at Bloomberg.
Recall that the decline in producer prices in 2016 caused a drop in the yield of Chinese government bonds, and after that there was a collapse of stock indices. Then experts started talking about the "hard landing" of the Chinese economy. The situation may repeat itself. And this can happen much earlier than the next presidential election in the United States, which is waiting for the Celestial Empire, with high hopes for the defeat of D. Trump.
"Economic problems and the likely decline in the Chinese stock market may force the country's authorities to make serious concessions and conclude a trade deal with the US," Julian Evans-Pritchard from Capital Economics said.
Trump bets on surprise
The American leader really wants to conclude a trade agreement with Xi Jinping, but his strategy is to force the enemy to guess. Therefore, he chose the right moment to announce something unexpected: plans to introduce 10% duties on imports of Chinese goods to the United States in the amount of $300 billion.
It should be recognized that the American side has enough ambitions in the current confrontation: a world without duties, and a fair "playing field" with China, and sustainable economic growth due to the opening of new markets, and the cessation of intellectual property theft.
"The President has repeatedly said that his ultimate goal within the framework of the world trade system is zero tariffs, absence of trade barriers and subsidies. He's rebuilding the American economy. This process is not easy and complicated due to trade imbalances. Therefore, we strive for fair, free and mutual trade with China," said Larry Kudlow, chief economic adviser to the White House.
Meanwhile, D. Trump continues to make attacks towards China, but does not give a clear idea of what will be the result after the potential conclusion of a trade deal with Beijing. He often talks about the growth rate of the US economy exceeding 3%, but so far Washington's trade tariffs are acting on US GDP in the opposite direction.
Yes, duties are beating on China, and theoretically, the United States is able to change the supply chain and push China to the periphery of world commerce. However, this does not guarantee free trade, which could bring the American economy to a new level.
"It is likely that the parties will be able to reach a reasonable compromise in the longer term, but investors will have a hard time on the way to it. Moreover, the risk that the situation could spiral out of control, has increased significantly", the DWS noted.
A trade war could escalate into a currency
According to some analysts, having involved the yuan in the trade war, Beijing is at great risk, as the devaluation of the national currency will lead to capital flight from the country. However, allowing the yuan to weaken, China hits D. Trump in a "sore spot", who has repeatedly expressed dissatisfaction with too strong greenback.
Further weakness of the yuan may increase the risks of foreign exchange intervention on the part of Washington, aimed at reducing the USD rate.
However, according to UBS experts, these measures can have the opposite effect and support the dollar.
"In order for the intervention against greenback to work, the growth of the US economy and the advantage of high interest rates should not be so obvious. At the same time, the growth prospects of the Chinese and European economies should improve, which raises certain doubts," the Bank's strategists said.
"A more likely outcome of the currency war is a further increase in uncertainty, which, ironically, could be positive for the dollar if investors are afraid of a slowdown in the world economy, and volatility will increase," they added.
In addition, interventions are rarely successful if they are made by the US Treasury without the approval of the Fed. The US Central Bank may limit the impact of this step on the markets.
"Even if D. Trump orders the Treasury to take part in the currency intervention in an attempt to weaken the dollar, the unilateral nature of such actions is unlikely to be anything more than a temporary influence," representatives of the National Australia Bank noted.
The yen is the main beneficiary of the escalation of the trade war
"The economic situation in the Land of the Rising Sun is far from ideal, but in the case of a market shock caused, for example, by geopolitics, the yen will be the best refuge," Rabobank economists believe.
"In recent years, the growth of the global economy has reduced the demand for safe haven currencies. For most of this year, expectations about easing monetary policy by global central banks balanced the flow of bad news related to trade conflicts and global economic problems. Thus, regulators stimulated demand for "risk" and suppressed the volatility of the foreign exchange market. However, Washington's determination to continue to put pressure on Beijing leaves little chance of an early conclusion of a trade agreement between them. Disagreements over intellectual property rights, the forced transfer of technology and subsidies to Chinese companies may be insurmountable," they said.
"According to our estimates, in the next couple of years, the escalation of the trade war will annually deduct 0.6% of the world GDP. This will increase the demand for protective assets. In this regard, we decided to lower the 12-month forecast for the USD/JPY pair from 108 to 104," Rabobank said.