How falling US stock markets can give China more leverage against Trump in the trade war
Nicholas Spiro says the US president has used the leading S&P 500 index as a yardstick of his success since taking office. Beijing could let the yuan slide further to drag the index down and discourage Washington from imposing steeper trade tariffs
Last week was another brutal one for Chinese equities. The Shanghai composite index fell a further 7.6 per cent, to its lowest level in four years. Foreign investors, who increased their holdings of onshore stocks following their inclusion in benchmark indices, are turning bearish. They sold US$2.4 billion of yuan-denominated shares last week through the trading link with Hong Kong, according to data from Bloomberg.
Yet China’s battered stock market has only been a sideshow for international investors in the past week. Instead, all eyes have been on the dramatic sell-off in US equities, this year’s most popular and resilient asset class.
The S&P 500 plunged nearly 7 per cent over a six-day losing streak. This wiped US$1.7 trillion off the value of the world’s leading share index, equivalent to 70 per cent of the value Chinese equities have lost since late January, according to Bloomberg.
The decline in US shares was so ferocious – the tech-heavy Nasdaq composite index suffered its worst rout since 2011 – that a gauge of global equities outside the US fell to its lowest level since April 2017.
The S&P 500’s losing streak is the longest since Donald Trump won the United States presidential election in November 2016. It is doubly significant because of the importance Trump has attached to the performance of the index since he took office.
Not only does he frequently take credit for the S&P 500’s impressive advance – up 22 per cent since his inauguration in 2017 – he has contrasted the American bull market with the bear market in Chinese shares as evidence that his administration is winning the trade war.
Stock markets have been on Trump’s side, as I explained in an earlier column, with US leadership in equities becoming much more pronounced this year. Yet last week’s sell-off came as the “America first” trade policy lost a little momentum. Although this can be attributed to a number of factors, from the recent increase in US bond yields to more attractive stock valuations in other regions, the fallout from the escalating trade war cannot be discounted.
A more vulnerable US equity market raises the stakes for the Trump administration, particularly given mounting market anxiety over the renewed decline in the yuan. The Chinese currency fell to 6.92 on Friday after the People’s Bank of China set the weakest daily fixing since February. According to Bloomberg, speculative bets that the yuan will weaken past the psychological threshold of 7 per US dollar have risen to a new high since the Chinese currency began falling sharply in June.
The S&P 500 – which is dominated by US multinationals, many of which derive a significant part of their revenue from China – tanked three years ago amid concerns about the Chinese economy and policy regime following the surprise devaluation of the yuan. If the trade war deepens, Beijing could press home its advantage by allowing the yuan to depreciate more sharply, straining the S&P 500 and hitting Trump where it hurts.
Robin Brooks, chief economist at the Institute of International Finance, argues that Trump’s use of the S&P 500 as a yardstick of his administration’s success is “an Achilles’ heel to US policymaking” and “a channel which China could reactivate … if trade tensions worsen”.
To be sure, Beijing would be letting the yuan slide at its own peril.
Lessons to draw from the President's Fed comments: (i) rumors the Fed is shifting hawkish are an illusion, we'll get the "dots" at most; and (ii) this administration is very focused on SPX, an Achilles heel to US policy making, esp. if China devalues more in the trade dispute. pic.twitter.com/5bQUnN3HEB
— Robin Brooks (@RobinBrooksIIF) October 11, 2018
A much weaker yuan could drag China back into 2015-16 territory, increasing the scope for a disorderly depreciation and capital flight that proved so damaging then. The Chinese currency is already a major focal point for market anxiety and the Trump administration is weighing whether to label China a currency manipulator in a report due out this week.
Yet a weaker yuan would be a logical response to more punitive tariffs on Chinese goods. Beijing has, for some time now, been signalling that it is not losing sleep over a further drop in the currency, partly because it has tightened capital controls.
The recent shift to more growth-supportive policies makes a breach of the 7 per US dollar level more likely, especially if the greenback strengthens further. The challenge for Chinese policymakers is to convince markets that the pace of depreciation will remain orderly.
Make no mistake, any China-induced fall in the S&P 500 would be doubly painful for mainland stocks. But putting more pressure on the “America first” trade policy in the coming weeks and months is one way to make Trump think twice about slapping steeper tariffs on Chinese imports. Last week, he pinned the blame for the sell-off on an “out of control” Federal Reserve. He has been so sensitive about the direction of the stock market that Beijing may have more leverage than many think.
Nicholas Spiro is a partner at Lauressa Advisory