Two camps of Trump administration

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The trade spat of US with China is covered by the media in strikingly different modes at absurdly frequent short periods. On Tuesday, after the Bloomberg reported that the negotiating teams of the two countries may be close to finding a common communication code, the WSJ reports that the countries are about to resume talks, starting on the ground that the previous trade proposals were unsatisfactory.

But already on Wednesday, the clear horizon has again clouded, the administration wants to raise the proposed 10 percent tariffs on 200 billion goods to 25%, in an attempt to increase pressure on the Chinese partners to bring them back to the negotiating table. Today, the market is unstable, though weakly noticeable in stock index futures.

The White house also appears to be divided into two camps, defending different ways how to deal with China.

US Trade Representative Robert Lightheather convinced Trump of the need to get concessions from China through tariff hikes, while leaning towards trade-offs Larry Kudlow and Stephen Mnuchin are betting on the talks. Trump himself seems inclined to count on the effectiveness of threats, since he rejected results of June negotiations, when China agreed to increase purchases of agricultural products by 70 billion dollars and hydrocarbons from the United States.

The deal concluded with the European Union gave confidence to Trump, because the US seems to have overcome the main risk of isolation associated with maintaining a relatively hostile trade policy. The New and Old World have agreed to use WTO to resolve issues on theft of intellectual property, the forced transfer of technology and influence on the economic sectors that benefit from state control. All of these claims are related to China so the plans of Chinese government to create an economic alliance against the US were mildly not successful.

The proposal to raise tariffs from 10 to 25% is not final and may not enter into force if the public hearing deems it redundant. Nevertheless, the news about the increase in tariffs saw swift reaction among investors. Futures for the Dow fell, the yuan weakened against the dollar but quickly recovered. In my opinion, we should not discount the news about possible negotiations, as the “doves” in the White House will continue to do their work. The new tariffs for $200 billion should come into force on August 30 and it will be very unreasonable for China to test the limits of their economy simply by ignoring threats. Therefore, we expect signals about a new round of talks and a relief rally in the yuan and the stock market in the US.

The flexibility of the Bank of Japan in the asset purchase program has borne its first fruits. After the Central Bank announced that it allows wider fluctuations in the profitability of 10-year JGB, yesterday’s revival of demand at the meeting turned into sell-off and the yield jumped to 13 basis points. Revived bond trading is aimed at getting profit from Central Bank interventions, since according to the statement, the regulator will prevent a sharp increase in yields. For the yen, the BOJ’s fresh stance is clearly bullish, as the transition to flexible yield targeting is a signal to policy tightening, though in distant future.

Today the meeting of the Fed is due where Fed funds rate is expected to stay untouched. The expectations of the two rate hikes in the second half of the year are solid, so Fed comments will be examined in relation to the potential inflationary effect of tariffs, which, with growing Trump rates, may take a threatening breadth for the economy. Milder growth forecasts in 2019 can provoke dollar sell-off, while the dollar could rise if the Fed really sees the possibility of accelerating inflation as a result of tariffs.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.
 

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