Coloma Capital – Trade War Tempest or Just a Squall?
Disclaimer: While an investment in managed futures can help enhance returns and reduce risk, it can also do just the opposite and in fact result in further losses in a portfolio. In addition, studies conducted of managed futures as a whole may not be indicative of the performance of any individual CTA. The results of studies conducted in the past may not be indicative of current time periods.
Trade War Tempest or Just a Squall? As the July 31st Fed interest rate cut was quickly overrun by the trade war tit-for-tat, we need to gain some perspective on expected impact of the US/China interaction in early August without the hype too often seen in the media. On August 1st, Trump stated that he intends to place a 10% tariff on the remaining $300 billion-ish in Chinese exports to the US as of September 1st. The prior statements were a 25% tariff (notably higher) and at an indeterminate date (easily ignored by the markets). A lower tariff that can possibly be fully absorbed by Chinese firms may ruffle some feathers but would not be a crisis. The Chinese response of cancelling nebulously-defined agricultural sales (note that pork shipments are full speed ahead, despite the existing Chinese tariff) would be partially matched off with lower US grain production from the poor spring weather. There are also some reports that the Chinese tempered their Brazilian soy purchases which implied intrinsically lower Chinese grain demand. In other words, this first response was justification for something they wanted to do anyway.
In addition, the Chinese allowed their currency versus the dollar to dip below the psychologically critical 7.00 level. This action would have several effects – to help Chinese exporters absorb US tariffs and discourage imports from the US would be an obvious answer, but the CNY cannot slide too far without negative consequences. At the end of last year, there was officially $1.9 trillion in foreign-denominated debt, which becomes harder to service as the CNY loses value. Furthermore, $1.2 trillion was listed as short term, coming due in 2019. Daiwa Capital Markets estimated that the real foreign debt is between $3 trillion and $3.5 trillion due offshore borrowing in Hong Kong, New York and the Caribbean. If true, foreign-denominated debt owed by China would be equal to all of its vaunted foreign exchange reserves, which have not grown for the last three years. Finally, if China sold off all its US Treasury bonds, ($1 trillion roughly), what would it do with the money? If the government brought it back to China (buying CNY, selling USD), that would reverse this devaluation and undermine their own action. Our conclusion? Both sides jabbed each other but no truly dangerous consequences… yet.