Chinese stocks decline on tariff fears, yuan falls

Summary:

• Chinese indices take another hit on Thursday ahead of US tariffs coming into effect tomorrow
• Offshore yuan keeps sliding as speculators have no incentive to buy it against the dollar
• IMF warns about an inflation breakout on the back of the US fiscal stimulus

Chinese indices are set to close another session in a row substantially lower as investors fret about US tariffs coming into effect as soon as tomorrow. Let’s recall that the Trump administration has said earlier that it will slap China with $34 billion levies on 6 July whereas Beijing has vowed to retaliate yet the same day if it happens. Over the past hours we were offered reassurance from the Chinese Ministry of Finance that it will ’absolutely not’ fire the first shot in a trade war with the US. These remarks contradict reports coming from local media that China could be the first in implementing duties on goods imported from the US ($34 billion as well). To sump up, one may notice that a ball is currently on the US court, and the further development of trade frictions between the two biggest economies in the world could depend on whether the US decides to announce tariffs at the midnight. As of 7:00 am BST the Hang Seng is falling 2.2%, and the Shanghai Composite is going down 1%. The Japanese NIKKEI closed 0.8% lower alike.

The downward pressure on the China’s offshore yuan weighs on the Hang Seng. Source: Bloomberg

 Another reason why China’s stocks have been underperforming lately is the ongoing slump of the Chinese offshore yuan. As depicted at the chart above, the USDCNH has soared recently (its axis has been reversed) which has coincided with fresh declines seen on the Chinese Hang Seng (CHNComp on xStation5). Notice that the downward pressure on the CNH is unlikely to come off any time soon taking into account that the cost of being short yuan continues dropping. Looking at the USDCNH forward points curve one may spot that the curve has substantially lowered compared to the shape seen a week earlier. It means that foreign investors face quite negligible costs should they want to short the CNH, and therefore they do not seen any incentive to be long CNH just due to positive carry. For instance, 1-month forward points have declined to below 35 this morning from above 120 seen 15 days earlier. This constitutes a massive cost reductions encouraging investors to keep on selling the CNH and thereby pushing the CHNComp much lower.

The CHNComp sees another week of heavy falls, and the ongoing sell-off could last up to 10000 points where there is the likelihood sellers might face a major hurdle. From a fundamental point of view the slump may come to an end should trade tensions along with downward pressure on CNH ease. Source: xStation5

Finally let’s mention the yesterday’s IMF report concerning the United States where the fund stressed its anxiety with respect to the US fiscal stimulus. The IMF wrote that the stimulatory fiscal policy there would trigger an inflation break-out and the Fed would have to raise the policy rate quicker. Keep in mind that the fund projects the Fed funds rate being between 3.5% and 3.75% in 2020. This is obviously the point many economists pay attention to, and together with rising wage growth and supply constraints in the US economy this scenario does not seem to be completely impossible.