• Before entering what was supposed to be the last round of trade talks, Trump threatens new tariffs on all of US imports from China. It is a huge turn of events that adds renewed uncertainty to the outcome of the trade talks.
  • It may be that it is just a bluff and an attempt to squeeze out more of China, but bullying rarely works on China and Trump’s threat could backfire.
  • China may very well decide to skip talks this week, which could be the start of a new escalation of the trade war that would give a big hit to risk sentiment and could derail the brewing signs of recovery in the global economy.
  • However, with Trump going into the election campaign, we still do not think he would risk a no-deal outcome that would most likely derail the stock market rally and cause a dive in economic sentiment. Our baseline is therefore still a deal by the end of Q2, but uncertainty has clearly gone up.

On Sunday night, the US-China trade talks took a dramatic shift for the worse as Trump tweeted that he is going to raise tariffs on USD200bn of imports from China from 10% to 25%. He also said that another USD325bn of Chinese goods will be tariffed ‘shortly’. This is a huge turn of events as only yesterday Trump was saying trade talks were going “very well” and his Treasury Secretary Stephen Mnuchin last week said the talks in Beijing had been “productive”.

It is not clear what has led to this sudden turn of events. Trump said in his tweet “The Trade Deal with China continues, but too slowly, as they attempt to renegotiate. No!”. Whether something happened over the weekend or he is simply bluffing to put pressure on China in the last round of this poker game is unclear. No doubt the uncertainty over the coming week’s trade talks have gone up sharply. Trump’s tweet seems so aggressive that it some of his most hawkish advisers (Lighthizer and Navarro?) may have fired him up with tough talk about China. There has been signs of impatience in the US in getting the last bits solved and maybe Trump has concluded that he needed more tariff threats to get China to give more concessions.

On Friday, we put a 75% probability on a trade deal this week. That is clearly too high now, and we are back in unchartered territory.

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A key question is how China will react to the threat? One thing is clear. China does not like to be bullied. This has to do with the importance of saving face in Chinese culture as well as China’s history of being bullied and occupied by foreign powers during what China calls the ‘century of humiliation’ from 1840-1949. So far in the trade war China has refused to negotiate whenever it felt it had ‘a gun to the head’. In addition, as a sign of good faith Chinese leaders have tried to deliver a lot to Trump even before a deal is made by increasing purchases of US agricultural products, passing a Foreign Investment Law that bans technology transfer, raises protection of intellectual property rights and stresses equal treatment of domestic and foreign companies.

Trump’s tweet could be seen as a stab in the back that China might not put up with. The coming days will be very decisive for whether we are in for a real new escalation or whether things calm down again and a deal is reached. Sources overnight suggested that China considers skipping the talks this week and not go to Washington. This would be in line with China’s previous behaviour last year when threatened by Trump.

Overnight, China eased monetary policy further by cutting the Reserve Requirement Ratio for small banks and midsized banks to 8% from 10-11.5%. A targeted cut was expected but that it comes now could be another sign that Beijing is buckling up for a new trade fight with the US and sending a signal that they will not bow to US bullying. Last year when Trump pulled out of talks in May, China was very quick to ease monetary policy.

Chinese stock markets are down more than 5% this morning and markets will now price in a risk of full blown trade war. Even though both sides want to make a deal, the path there is now very unclear and a scenario in which Trump taxes all of Chinese exports to the US has to be factored in as a possibility again.

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