“This Whole Episode Suggests China Is Deeply Worried About US Trade Sanctions”

In the 24 hours since Bloomberg headlines proclaimed China would slow or halt its Treasury purchases, a number of events have taken place:

President Trump, while praising China over North Korea, suggested they “could do a lot more” in an interview earlier today.

Treasury Secretary Steve Mnuchin mentioned ‘trade sanctions’ during his appearance in The White House press briefing this afternoon.

And then tonight, Commerce Secretary Wilbur Ross has sent the White House the results of an investigation of steel imports that could lead to new tariffs on Chinese shipments, the Commerce Department announced Thursday.

The Commerce Department statement didn’t disclose the findings of its inquiry into whether steel imports threaten U.S. national security. President Donald Trump has 90 days to act on the report. He can respond to any threats by imposing tariffs and quotas or entering into talks with foreign producers to find a solution.

All of which suggest a common message from Washington that they stand ready to escalate protectionism amid China’s looming petro-yuan future implementation.

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Furthermore, as Rafiki Capital Management’s Steven Englander notes, the whole episode suggests that China is deepy worried about the possibility of US trade sanctions.

As we expected yesterday, China has denied the story on the shift from US Treasuries, emphasizing their commitment to being a responsible participant in the international financial system.

My wife says I am the most naive guy in any room I am in, so I believe both stories are true (with a caveat that I mention below).

It is just that we live in a world of situational/Snapchat (i.e. disapppears in 15 seconds)/temporary truth. So yesterday’s truth dissipates and is replaced by today’s. 

 

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A couple of takeaways

1) The whole episode suggests that China is deeply worried about the possibility of US trade sanctions, and more broadly the US taking a more assertive in rectifying perceived issues in the bilateral trade relations. Every Administration goes through an episode of promising to deal with Chinese trade interventions and ends up with a watered down, vague agreement. China’s pre-emptive action suggests that this time the level of worry is different.

2)  It is hard to see that China is better off today than two days ago. In between the story and the denial, there was a very strong Treasury auction and at the worst the damage to equity markets was small. By the close equities had recovered most of their losses, and even though yields are back up for other reasons, equities are still going strong. If anything, it suggests less vulnerability in asset markets, rather than more.

3)  There is a way of having a major impact on US asset markets. But that would involve a longer term selling of US fixed income assets and reduction in Treasury holdings. The announcement that their holdings had dropped significantly would have a much bigger impact than the indication that it was something they were thinking about. As was the case yesterday, there is an element of shooting yourself in the foot when you tank an asset of which you are a major holder (although possibly they bought at the low late in the day). Given the size of the holdings, it is really difficult for them to back out — the only time to do it would be when others are buying or there is some sort of QE program so they are not always on the offer.

4) NB: The trading pattern of the day before the story came out suggests that China may have been hedging some of its bond holdings, which suggests that perhaps there was more than a grain of truth to the story. 

and I repeat my advice to the Chinese authorities:  It’s easier, cheaper and risks less unwanted spillover to wave USD100k in a trailer park, get a dossier and derail the US government from any significant policy action for another two years.  

 

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