SPECIAL REPORT: US-China Playbook, Where To From Here?


*US-China trade talks set for an Oct 10-11 showdown
​*Equities currently on the fence and wait for headline risk 
*Meaningful outcome unlikely due to major sticking points
*Harsher punishments ahead if tensions escalate further



Talks scheduled for Thursday

Trade negotiations between sparring powerhouses, US and China, are set to resume Thursday October 10 in Washington with China back on Tuesday from its week-long holiday. US-Sino talks, ongoing for some two years now, broadly show the difficulty of making meaningful progress to date between the two nations notwithstanding the symbolic gestures made of late. The gestures in which Trump delayed tariff hikes by two weeks and China waived tariffs on new US Soybean purchases were looked upon favourably at the time, but ultimately, eschew the more complete deal the US are hanging out for.
 

Headline risk elevated

Trump has been audible about the long list of issues he has with China, and so, it is for exactly this reason combined with China's inability to acquiesce to Trump's extensive list of demands, that a meaningful deal is likely still out of reach for some time. At a minimum, expect plenty of headline risk which leads to knee-jerk reactions and heightened volatility across the FX and equities complex. Below, we help summarise what a positive outcome looks like between the strong-willed nations and how Trump might escalate US-China trade tensions in the case of further disagreement.
 

Intellectual property issues one of many major obstacles

Intellectual property protection (IPR), forced technology transfer and state subsidies as Trump sternly spoke about at the UN Forum continues to be a major sticking point in getting any meaningful breakthrough on persistent US-China trade tensions. China, who don't look keen to discuss these sensitive topics at the upcoming talks, claims it's made progress in these areas - but not enough to alleviate US concerns as suggested by Trump and close advisors. Therefore, following on this rhetoric, any positive outcome that comes of these talks is most likely going to resemble another symbolic gesture that creates the framework for more discussions going forward. In other words, a temporary pause, not dissimilar to the few seen in the past, that effectively "kicks the can down the road" and fails to bridge the gap on the major problems at large. 
 

A positive outcome but how meaningful?

From the US end, this could arguably manifest to be another delay of the 5% tariffs due to kick in October 15 or a more significant reprieve for Huawei who were granted a 90 day general license back in early August. While from China's side, China may disseminate more tariff waivers or follow-through on an agreement to purchase a considerable amount of US farm products, in particular Soybeans, that relieves some of the financial pressures faced by US farmers. And though said outcomes screen positive, likely to boost risk sentiment and see equities bid - it's difficult to imagine how these smaller deals alleviate the longer-term concerns on economic growth driven by trade and investment uncertainties. A reduction or removal of previously imposed tariffs would be a significant softening in stance from the US but likely requires a breakthrough in one of the thornier issues. The US currently have tariffs on around US$375bn of imports to China's US$185bn. 
 

A breakdown in talks would be disastrous

In the scenario where talks turn sour and tensions escalate, there still exists a long list of measures that both sides could implement which further cements the US-China trade war as the most economically devastating in the history of all trade conflicts. Trump previously made mention of tighter US security laws that could delist US listed Chinese firms and restrict China's access to US financial markets, though, this represents an extreme risk and is therefore highly unlikely at the moment. The more likely turn would be additional implementation of tariffs and export controls around sensitive IP. On the other side, China has room to impose more tariffs albeit not proportionally to the US given the trade imbalance. In an unconventional retaliation, China could devalue the Yuan meaning USDCNH higher despite having said it won't "engage in competitive devaluation" to boost exports. Given China also holds a significant percentage (<20%) of US Treasures, one might argue that China could sharply reduce its holding and indirectly help to drive USDCNH higher. 

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US-China Playbook. Source: ThinkMarkets
 

Most likely reactions

A marginally positive deal:
  • ASX 200 up alongside a broad equity bid. Resistance around 6,650-60.
  • USDCNH down but retain longer-term bullish bias. 
  • USDJPY up but retain longer-term bearish bias. A test of 108 to make a triple top. 
  • AUDUSD to reach for 0.68. NZDUSD to breakout of consolidation to test Sep 25's lower high ~0.635.
A bad outcome: 
  • ASX 200 to test 6,400 alongside a broader down move in equities to last Thursday's lows. 
  • USDCNH up to make a higher high above 7.16 and then to test 7.2 August highs. 
  • USDJPY breaks 105.8 and finds support around 105 with a longer-term target around 104. 
  • AUDUSD and NZDUSD to fall and edge lower. 



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