Wall Street Warns Against Bets on October U.S.-China Truce

(Bloomberg) --

The next round of U.S. tariff hikes on China is little more than two weeks away, though equity and foreign-exchange markets aren’t signaling any obvious concern.

That may set things off to a rocky start in the fourth quarter, a period when thinning liquidity is perceived to increase the risk of volatility. For their part, strategists at some of Wall Street’s biggest banks -- including Citigroup Inc., JPMorgan Chase & Co. and Goldman Sachs Group Inc. -- warn against expecting any truce in the upcoming round of U.S.-China trade talks.

“We have more conviction that, without a circuit breaker, escalation continues over the medium term, meaning any pause is fleeting,” Morgan Stanley strategists including Michael Zezas wrote in a note to clients Monday. “Investors should price in all announced actions (i.e., tariffs on both Oct. 15 and Dec. 15) even if further delays or pauses are announced.”

While news about Trump administration deliberations on curbs on U.S. investments in Chinese companies hit stocks Friday, S&P 500 futures and the yuan both rose in Asian trading Monday. That’s after China confirmed that its top trade negotiator, Vice Premier Liu He, is still heading to the U.S. for negotiations after national holidays end Oct. 7.

Yet the Morgan Stanley team highlighted that rounds of top-negotiator talks lately have been followed by tariff escalation, not by an easing in tensions.

Indeed, President Donald Trump on Aug. 1 announced a new round of tariff hikes shortly after the principal U.S. negotiators returned from talks in Shanghai. And that triggered the worst month for global stocks since May -- when investors were also handed with an escalation in tariffs. In currencies, the yuan slid through 7 per dollar, for a time spooking investors across emerging markets.

September saw both stocks and exchange rates settle, as the U.S. and China announced goodwill gestures that took tensions down somewhat.

The next round of headlines may not be so cheery.

“While trade talks so far have been noted as constructive and the delay of some tariffs led to some market optimism, we do not expect the Trump administration to reach a deal assuming continued strong U.S. economic and financial conditions,” Cesar Rojas, an economist at Citigroup, wrote last week.

Rojas flagged that, besides the upcoming tariff hikes, the U.S. Treasury’s semiannual foreign-exchange report is due in October. The department already has labeled China as a currency manipulator. Now the focus is whether the Commerce Department has any related announcement on treating the exchange rate as amounting to a subsidy, clearing the way for countervailing duties, according to Rojas.

One new element going into the upcoming negotiations is Trump’s impeachment troubles in the House of Representatives. JPMorgan analysts noted that those could have a bearing:

“Trump may experience an epiphany that inclines him to accept a weak offer from mainland China to end the trade war,” John Normand, JPMorgan’s head of cross-asset strategy, wrote on Friday. “But the adverse scenario is also credible: realizing Trump’s vulnerability, China may slow-walk negotiations and even court another tariff hike, on the expectation that another year of mutual stress might raise the odds that Trump loses the 2020 elections.”

JPMorgan’s base case is for talks to drag into next year. And the bank sees the yuan sliding by year-end to 7.35 per dollar, the weakest since 2007.

Bank of America Merrill Lynch is even more bearish on China’s currency, seeing it tumbling to 7.50.

“Cautious optimism is building that a narrow deal can be achieved” in the upcoming talks, Claudio Piron, a Bank of America strategist in Singapore, wrote in a recent note. But even if there is a truce, the yuan may still slide, he argued -- with China likely to ease monetary policy and try to offset existing tariffs through depreciation.

Goldman isn’t quite so bearish on the yuan, keeping its near-term target at 7.20, compared with 7.1375 in Shanghai trading Monday.

But Goldman’s economists offer some sobering broader context for major American trade disputes over history.

“In most instances, tariffs remained in place for several years, with a median duration of three-to-four years in our sample of major postwar disputes,” analysts including Alec Phillips wrote on Friday. “The more complicated conflicts saw periodic detentes and in some cases remain unresolved years or decades later.”

To contact the reporter on this story: Christopher Anstey in Tokyo at canstey@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Joanna Ossinger, Brendan Murray

©2019 Bloomberg L.P.