Trade Could Be a Spark, But Not the Cause of USDCNY 7+

Caixin: Opinion: Will Trade War Push Yuan to ‘Break 7’?
So how should we interpret the differing market reaction to the trade tensions? The U.S. markets were responding not only to the heightened trade tensions but also to weaker-than-expected economic data which made investors increasingly wary of taking on risk, leading to a decline in the price of risk assets (such as equities and commodities) and the risk-free rate (equal to the interest paid on three-month Treasurys which are considered the safest investment an investor can make).

But Chinese markets behaved differently. It is widely believed that China’s markets would see a greater negative impact from the trade war than those of the U.S., but this has only been reflected in the exchange rate. The relative decline in China’s stock market was close to that of the U.S., when their respective volatility characteristics and the standard deviation of daily fluctuations are taken into account, and the decline in Chinese government bond yields was significantly less than the drop in Treasury yields. Prices of industrial products in China are also rising, moving against the trend.
The trade war could be the straw that breaks the camel's back, but it is only a piece of straw. The trade friction pales in comparison to credit growth and central bank malfeasance, to name two of the biggest threats to the global economy, not just China and the United States. If China had a clean balance sheet it would be laughing at this trade war.
In the short term, if China’s GDP performance and employment situation remain within a range that’s acceptable to the government and within its expectations, and given the counter-cyclical adjustment that’s taken place in monetary policy since the beginning of the year, there is unlikely to be any further easing of monetary policy as a result of an escalation of trade tensions.
Trade is a sideshow as it was during the 1930s. Trade may matter for China if it is part of a much larger U.S. containment/isolation strategy, but the economic impact is limited. Should falling U.S. exports tip the reserve balance into monthly deficit again, depreciation pressure could ignite, but trade is only the spark. As I laid out several years ago, I expected yuan devaluation would spark a trade war, not vice versa. Without China's monster credit creation, the economy would be growing at a healthy clip and appreciation pressure would be the worry regardless of which way reserves move or trade disputes.

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