Trump pressuring China
This is an abrupt turn of events as media reports from both sides up to end of last week have suggested that trade talks were progressing closer to a deal.
All the evidence suggests that 90%-95% of the trade issues were done with the remaining issue related to the ‘enforcement mechanism’. Also still under negotiation is how much tariff should be rolled back and to maintain to ensure that China obliges to the agreement down the road. The threat tactics used by Trump may not work on China.
This is because putting a gun against Beijing’s head to cut a deal at the final hours is a dangerous proposition that may roll back the entire trade negations, particularly at this point, where China seems to have achieved some growth stabilization, as opposed to the sharp economic downturn it faced, when US tariffs were first imposed in the summer of 2018.
The good news, though, is that China has officially announced that its US trip of some 100 Chinese officials scheduled on Wednesday (May 8) will still go ahead. Instead of an outright cancellation and confrontation, there is still a good chance for more negotiations to prevent additional tariff impositions abruptly by Friday.
New successive cuts to RRR
This morning, China announced the long-awaited targeted reserve requirement ratio (RRR) cut to rural and small banks as a clear response from Beijing to counteract the negative trade news.
Effectively, the newly targeted RRR cut will average about 20-30bps to a lower level at 8%. This suggests that monetary policy will likely stay expansionary should external pressure from trade re-emerge as the main drag on the economy again.
Still room to stretch out
As of writing, Chinese and Hong Kong equity indices were down about 3%-7% and CNH/USD depreciated by as much as 1% while Chinese credits have widened mildly. For MSCI China, valuation has become marginally stretched before today’s slide. This comes with price-earnings (P/E) multiples just above past five-year average of 12x, but still below 2018’s January peak at 14.5x. A return to the December’s low of 9.5x (when economic deceleration was in full force) should be an extreme case especially in view of China’s policy easing has already produced some stability to the economy.
In the worse-case scenario of trade deal evaporation, we suspect that market will return to the situation in 2H/18, in which investors would look for China’s policy easing to gauge the economic and earnings outlook.
On this, we see China should still have room to stretch out monetary and fiscal stimulus in 2H/19 versus the current plan to tame down the former policy after the 1Q/19 hefty liquidity injection. The economic consequence may be a later concern as emergency measure takes priority.
The central bank has fixed CNY/USD weaker by 0.0183 or 0.27% at the open this morning after last week’s long holiday. The RMB is likely to have more near-term downside risk with the fading of political goodwill on the currency around the trade negotiation.
Chief Asia Investment Strategist