By Chan Kung and Wei Hongxu*
As the United States and China signed a key “phase one” trade deal, the United States removed China from the list of currency exchange manipulators, releasing the signal of “truce” for the financial war between the two countries. This signal means that the temporary elimination of uncertainty between China and the United States is good news for their respective financial markets.
Researchers from ANBOUND believe that the temporary easing of the U.S.-China trade war will be beneficial to the capital markets of the two countries, which will help the RMB (renminbi) exchange rate and capital market to recover in the short term. U.S. stocks were obviously stimulated by the good news. On the January 14 local time, the Dow Jones Industrial Average (DJIA) broke through 29,000 points and hit a record high.
Presently, the United States’ removal of China from the list of currency exchange manipulators has a significant impact on the RMB exchange rate. Although the U.S. currently has no practical measures on the RMB exchange rate issue, it appears to be a bargaining chip created by the U.S. Yet, the accusations of “exchange rate manipulators” represent uncertainty that will have a great impact on financial markets and foreign trade. ANBOUND has previously suggested that the most direct and prominent issue of U.S.-China trade friction is the RMB exchange rate. The relaxation of the trade war is of great significance to the stability of the RMB exchange rate. The elimination of this hidden danger is undoubtedly beneficial for the RMB exchange rate and it has practical effects on restoring confidence in China’s economy and capital markets. The RMB depreciated to the level of U.S. Dollar 1 to RMB 7.18 in early September-2019 last year and began to appreciate after the U.S.-China trade relations eased in October. On January 14, the median price of RMB against 1 U.S. Dollar was 6.8954, an increase of 309 points from the previous day and a new high since August 2, 2019.
The onshore and offshore RMB continued to rise and both rose above the 6.87 mark. However, in the long run, there is little room for the renminbi to rise further and it may stabilize near the level of U.S. Dollar 1 to RMB 7. This is the result of tacit understanding and market choices between China and the United States. As far as the Chinese and U.S. governments are concerned, the U.S.’s removal of China from the exchange rate manipulating country lies in China’s commitment to avoid competitive devaluation and the RMB has already appreciated. For China, with the changes in China’s foreign trade and investment structure, it is no longer possible to gain more advantages from currency depreciation. Therefore, the stability of the RMB exchange rate has a common interest that is acceptable to both parties.
In the long run, the gradual slowdown of the Chinese economy and the decrease in foreign exchange reserves caused by future increases in imports will have an impact on the exchange rate of the RMB. The continuous appreciation of the renminbi is not practical from a market perspective. Some market participants also said that the RMB exchange rate can better reflect the market supply and demand relationship after the temporary elimination of policy uncertainty. This will lead to obvious increase in flexibility. The RMB-U.S. Dollar exchange rate will not be a unilateral trend but will settle on a reasonable equilibrium maintaining two-way fluctuation. A Reuters survey also shows that the vast majority of market players are cautious about the RMB’s rise and believe that this rise will be unsustainable. Many financial institutions still believe that China’s economy will continue to slow down. According to researchers from ANBOUND, there is still depreciation pressure on the RMB-U.S. Dollar exchange rate in the coming period of more than 2 years because many structural problems of the Chinese economy have not yet been resolved. The stability of the RMB exchange rate can play a very important role in the trade and investment of the real economy. At present, the conclusion of the first-phase trade deal between China and the United States is undoubtedly positive for bilateral trade and direct investment. Changes in trade and direct investment will be a long-term and gradual process. This process will ease the pressure on China’s external environment.
The financial impact is short-term and direct. Temporary elimination of uncertainty and asset valuation will be directly reflected in the price of the asset. However, since the announcement of an agreement by two sides in December, these positive effects are gradually being absorbed by the capital market and a large part has been reflected in changes in the stock market. U.S. stocks had repeatedly hit record highs under the protection of the Federal Reserve’s monetary policy. The S & P index reached 3288 points, the Nasdaq index rose to 9273 points and the Dow Jones Industrial Average index reached a historical high of 28907 points. It broke through 29000 points on the January 14, 2020. Meanwhile, Chinese A-shares have continued to rise by nearly 10% since December last year 2019, maintaining a continuous upward trend. For that matter, a temporary revival of China’s capital market has emerged.
However, long-term stock market trend cannot be separated from the internal environment of the Chinese economy. The structural reform of the economy and the reform of the financial supply side are under great pressure. The internal dynamics of the economy is not strong and the trend of accelerating and decelerating growth still continues. In this case, although the market environment has greatly improved and breakthroughs have been made in individual areas such as the science and technology board, overall there is still lack of sustained upward support and the market is still facing speculation. As chief researcher of ANBOUND Chan Kung said, “Today, China still lacks the ability to provide simple ways to achieve wealth”. Therefore, China’s capital market is still far from a sustainable bull market. The U.S. stock market is also inseparable from the realities of the U.S. economy.
Our judgement is that U.S. stocks will continue to rise, probably surpassing 30,000 points and continue to hover there. Under the excess liquidity of U.S. stocks, there has been an “asset shortage”. Capitals are concentrated in the head corporations and hence pushed up the index. However, small and medium-capital stocks have not changed much. In the long run, the confidence of the U.S. capital market and the actual problems in the United States, including political, economic, income and population issues, will be increasingly exposed. At that time, there will be intense fluctuations around 30,000 points. Looking at the long-term prospects of U.S.-China trade frictions, although they will remain stable for a certain period of time, there is still great uncertainty and this will continue to affect financial markets in the future. Although the two parties are about to sign the first phase of the trade deal, the implementation of the deal will face tough tests.
In addition, negotiations in the second and third phases will be more difficult, the process will be more tortuous and the prospect is not optimistic. Even some analysts have said that even if the first phase deal is signed, the RMB will still be highly volatile because the market will then begin to question whether there will be a second or third phase deal. These long-term uncertainties will bring volatility to the capital market. As revealed by the analysis of ANBOUND, the friction between the United States and China will be long-term. This is the main axis after the relationship between the two parties enters into the strategic competition and cooperation period. Trade wars, financial wars, science and technology wars will be intertwined, followed by rise and fall. This will play the role of “gray rhino” in the financial market for a long time in the future. This will constitute long-term hidden danger for the financial market.
Final analysis conclusion:
The cancellation of the U.S.’ allegations of China as a currency manipulator and the imminent signing of the first phase of U.S.-China trade deal means that the elimination of short-term uncertainty will bring about a moment of relief to the capital markets of China and the United States. However, in the long run, the changes in the internal and external environment are still difficult to be optimistic and the long-term risks cannot be ignored.
*Founder of Anbound Think Tank in 1993, Chan Kung is now ANBOUND Chief Researcher. Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung’s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
*Wei Hongxu, graduated from the School of Mathematics of Peking University with a Ph.D. in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing. Established in 1993, Anbound specializes in public policy research.