We’re revising our yuan forecast again and expect far more volatility

Last Friday, China surprised markets by imposing new tariffs on more US goods imported into China.The retaliation in terms of the amount is small (simply because China exports more goods to the US than it imports), so in principle this shouldn’t have much of an impact on the US. It could ignore this - after all it was retaliation.

Another perspective on the entire situation is the flurry of tweets that came almost immediately from President Trump displaying his anger. The Chinese tariffs seem to have hit a nerve.

This marginal increase in tariffs might not be a substantial issue for China as the initial tariffs should have already been enough of a hindrance for Chinese businesses exporting to the US.

But with the surprise increase in tariffs, the Chinese action pretty much had the desired impact on the stock market.

The ball is now firmly in China's court. We think imposing more tariffs isn't the most effective way to create more hurdles for a Trump Administration that will soon begin to campaign in earnest for the 2020 presidential elections. Instead, China could probably cause more disruption if it keeps catching US stock markets - as well as potential Trump voters - off guard.

There are two possibilities open to China:

1. Unreliable entity list: Inclusion of any US companies in the list means those companies cannot tap into the Chinese market. This is a very powerful tool that has the potential to lead to increased volatility as well as periods of sudden yuan weakness.
2. Firm stance on trade talks: Talks without progress are more likely to provoke additional tariffs from the US. Even though this is to be expected, it is likely to weaken the yuan significantly. USD/CNY could cross 7.18 (the recent high) to near 7.20. This alone, without any retaliation from China, has the potential to create further market disruption.