The US-China trade conflict shows no sign of de-escalating anytime soon, as the White House banned Huawei from selling equipment to the US market and required US companies to obtain licences in order to sell chips and technology to Huawei.

Meanwhile, the Trump administration also decided to postpone auto tariffs with Japan and the EU, in an attempt to unite the allies and focus on the trade negotiations with China. Recent measures carried out by Beijing and Washington have weakened the outlook of a positive deal to be struck in the G20 meeting next month.

Meanwhile, China’s technology giants Alibaba and Tencent (700 HK) have both beaten market expectations with their Q1 earnings results. Alibaba’s revenue surged 51% YoY and active users increased by 100 million, driven by penetration into less-developed cities. This result comes in line with recent retail sales data, which shows a 22% growth in online retail while overall retail growth slowed to only 7.2%. Tencent’s earnings was shored by fintech and cloud revenue, which offset a slower gaming segment.

For the past few days, markets have chosen to ignore the tremendous downward pressure brought on by the trade war between the US and China, hoping there will be a solution in the June G20 meeting. After 40 years of opening up, China’s economy is deeply integrated into the global supply chain and trade network. Once this system is broken or mal-functions, the whole Asia-Pacific region will likely suffer. 

The currency market, in particularly USD/CNH serves as a great indicator of risk sentiment since the trade dispute reignited in early May. A fast depreciation of CNH was accompanied by a sharp selloff in risk assets globally, while the USD remained relatively strong. In the past few days, USD/CNH held on a 6.9 level, which helped to alleviate concerns over capital outflow and calmed market participants.

In the near term, equities have shown signs of oversold, but in a worst-case scenario that the US and China couldn’t reach a common ground on key issues and trade tariffs persists, this selloff will be just the beginning of a deeper correction.

Yesterday, China data came below expectations, with retail sales, industrial production and urban investment all falling from the previous month. It suggests the economy is still testing a bottom and it now may take a longer time to bottom out due to rising trade tariffs and the deteriorating relationship between Beijing and Washington.

Markets, however, seemed to take a different view. From Shanghai and HK equity’s rally yesterday, it suggests investors are waiting for more stimulus from Beijing to cushion the economic slowdown and get a better position at the negotiation table. This is a dilemma because more stimulus will lead to further yuan weakness, and it will also expedite the capital outflow from the mainland.

The China mainland equity market has surprisingly outperformed regional markets this week, up 4% since the tariffs took place. It is hard, as it always has been to try to understand the China market with conventional, fundamental methods. The consumer sector has outperformed the benchmark recently as investors believe China will shift from an export-reliant economic model to a more self-reliant one. This means policy makers will encourage more domestic consumption activities to alleviate the pain caused by trade tensions.

China is likely to carry out inflationary policy methods to boost domestic consumption, with accommodative monetary and fiscal policy. This means price levels will go up and the currency will weaken further. If tariffs persist, China will face difficulty in maintaining the hundreds of billions of trade surplus with the US, and the renminbi will lose one of its strongest backing to remain stable.

USD/CNH chart

 

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