US President Trump tweeted on 5 May that tariffs on the USD200bn in Chinese imports will rise from 10% to 25% on 10 May and that an additional USD325bn of goods will get a 25% tariff shortly.
Trump attributed his decision to the slower-than-expected progress of the US-China trade negotiations and China's attempt to renegotiate. US Trade Representative Lighthizer and US Treasury Secretary Mnuchin had implicated on 6 May that Chinese officials tried to re-open negotiation on areas that had already been negotiated. In the eyes of US negotiators, Chinese officials' moves represented an erosion of commitments by China and a big change in direction for the negotiation.
Regardless of Trump's tariff threat, China did not react violently. Instead, Chinese vice premier Liu He still chose to visit Washington for the 11th round of trade talks during 9-10 May. However, Liu failed to reach a trade deal with the Trump administration in his Washington trip, prompting the latter to bring the tariff hike into effect.
We attribute China's attempt to re-negotiate with the US to President Xi's confidence in the economy. In our view, China's success to stabilize its GDP growth (6.4% y/y) in Q1 on the back of proactive and flexible monetary policy, might have already made President Xi believe that the downside from a failed deal and higher US tariffs is diminished and that the need to hastily reach an agreement with considerable concessions given to the US, is no longer desirable.
Though both the Chinese government and the Trump administration described the 11th round of trade talks as constructive, investors obviously are no longer confident that the US and China can reach a trade deal anytime soon. Market participants are now instead more wary of the risk of no deal in the foreseeable future than they were in April or March.
We think the USD/CNH, which already reached as high as 6.87, will test 6.90 very soon (chart 1). In fact, faced with much heavier tariffs, China will allow CNY to depreciate moderately as compensation for the loss of trade competitiveness. Unless both US and China in the upcoming 12th round of trade talks succeed to make big progress, the markets will be starting to price a subsequent imposition of 25% of the tariffs on the remaining USD325bn worth of Chinese goods. That unavoidably will result in further extension of the USD/CNH's rally for 6.95 or even 7.00 during this summer.
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