New front in trade war thumps US markets

A screen on the floor of the New York Stock Exchange on Monday.Richard Drew/Associated Press/Associated Press

The news on Monday morning was especially unsettling: Tensions rising in the Persian Gulf over oil shipments, Hong Kong partially paralyzed by antigovernment protests, mass shootings in Texas and Ohio “shaking a bewildered nation to its core,” as The New York Times headline blared.

But the development that really rattled investors — at one point sending the Dow Jones average tumbling nearly 1,000 points — was a decline by China’s currency against the US dollar. The Dow ended the day with a loss of 767 points, or 2.90 percent, the biggest percentage decline of the year.

The ups and downs of the renminbi usually go little noticed outside the foreign exchange market. But these days, investors’ primal fear is that the escalating trade war with China will trip the US economy into a recession.

Can you blame them?

Last week, President Trump said he would impose new tariffs on a huge basket of Chinese goods starting Sept. 1, and US stocks had their worst week of the year.

On Monday, after China let its tightly managed currency hit the lowest level against the dollar since 2008, it sure seemed like retaliation for Trump’s new tariff threat.

A cheaper renminbi serves a dual purpose for Beijing: It makes Chinese exports less expensive for international buyers, easing the impact of American tariffs, and complicates life for US companies as they compete against Chinese rivals.

For good measure, China also stopped making purchases of US agricultural goods, which the Trump administration has been seeking to boost.

Then, after the markets closed Monday, the Treasury Department ratcheted up the dispute further, labeling China a currency manipulator.

Deep into July, stocks had been trading at record highs, thanks to hopes for a trade deal, which seemed possible as recently as a week ago. Now the two sides have entered a new, more dangerous phase of the confrontation: currency warfare.

“The response of the equity markets over the last several days to the reignition of protectionist trade policy by the Trump administration toward China has been incredibly negative, and not without reason,” Shannon Saccocia, chief investment officer at wealth manager Boston Private, said in an e-mail. “The economic impact of this potential next round of tariffs could be meaningful, as the goods subject to the next round are consumer focused.”

In March of last year, Trump tweeted “trade wars are good, and easy to win.”

That was early in his attempt to close the trade gap with China and end unfair tactics such as requiring transfers of US technology to Chinese partners. While most investors and economists dismissed the president’s tweet as nonsense, they agreed China’s trade practices were a problem that needed to be addressed.

The $200 billion worth of tariffs Trump ordered in July 2018 targeted goods mostly used by companies to make other products. But last week, after a brief round of talks yielded no progress, Trump announced a 10 percent levy on $300 billion of Chinese products, everything from sneakers to cellphones. He made the move despite opposition from some top advisers, according to The Wall Street Journal.

The reaction on Wall Street was overwhelmingly negative. The economy isn’t growing as fast as it was when the trade spat started. There is less room for error — a fact acknowledged by the Federal Reserve last week when it approved a quarter-point rate cut as insurance against damage from the trade fight.

“Tariffs are taxes; it is as simple as that,” said Luke Tilley, chief economist at Delaware-based Wilmington Trust. “Raising taxes reduces economic growth, just as the tax cut package boosted growth in 2018. . . . First-order impacts of the tariffs wipe out a substantial portion of the tax stimulus that had been created.”

So what happened on Monday?

China allowed its tightly managed currency to fall below 7 renminbi to the dollar, a symbolically important move that could make US products even less competitive against Chinese rivals. The president accused China of deliberately weakening its currency to gain an edge in export markets. China blamed Trump for “unilateralism and trade protectionism.”

Investors just ran for the hills. A weaker renminbi could prompt other exports-dependent countries to devalue their currencies, leading to a race to the bottom that causes a global recession.

Stocks fell sharply at the opening bell — at one point, the Dow was down more than 960 points. When the dust settled, the market closed at 25,718, 6 percent below its recent record. The broader Standard & Poor’s 500 fell 3 percent to 2,845. Stocks also tumbled in Europe, Japan, and China.

“The escalation dashes any hopes of a trade deal any time soon,” said Milton Ezrati, chief economist at financial communications firm Vested. “It also makes more immediate and severe the damage this dispute will have on the US economy.”

The yield of the benchmark 10-year Treasury note to fell to 1.714 percent, the lowest since before Trump’s election and a giant red flag that bond investors see increasing odds of a recession. In a switch from last week, investors are betting the Fed will cut rates several more times this year in hopes of avoiding a hard landing.

Then came the formal US declaration that it considers China a currency manipulator, a largely symbolic move that nonetheless escalated the fight once more. S&P futures markets slid in early Asian trading for Tuesday.

There are benefits to falling interest rates: mortgages and credit card borrowing are cheaper for consumers, and businesses can get cheaper loans for expansion. And some investors aren’t convinced a downturn is inevitable.

“We have the power to outspend, certainly in the near-term, any adverse effects from China,” said Jason R. Escamilla, chief executive of ImpactAdvisor LLC, a San Francisco-based financial adviser. “And I am less concerned that the net effect of all this will be higher new tariffs over the longer term. It’s too easy to cut a mutually beneficial deal as this escalates.”

That’s true. If Trump and Chinese President Xi Jinping can step back from the abyss, they would take a lot of pressure off their economies and financial markets. But that’s a big if.

“What will happen as a strong-willed US president tries to face down a small cabal of ‘hard to read’ leaders [in China?]” said Warren Ward, founder of Warren Ward Associates, a financial advisory firm in Columbus, Ind. “No one knows.”

Markets hate uncertainty. Expect more ugly days like Monday until the trade picture gets a lot clearer.