Top of the Morning: Navigating trade turbulence - China's perspective
The desk asserts that China's evolving response to U.S. trade tensions will influence emerging market dynamics moving forward. As noted in the UBS report, China has escalated its tariff retaliation against the U.S. and introduced measures impacting U.S. companies in response to recent policy changes, reflecting a complex landscape for traders. With an additional 15 percent tariff on U.S. agricultural products and a wider net of affected goods, the Chinese economy is signaling its position in the ongoing trade dispute. This move indicates resilience amidst challenges and a commitment to balance trade pressures, aligning with macroeconomic strategies observed globally.
What the desk is arguing
The desk frames this as a pivotal point for China's trade strategy, hinging on its response to U.S. tariffs and international market pressures. Per the full note source, recent retaliatory measures, including significant tariff hikes, suggest that China is prepared to navigate through potential economic headwinds driven by U.S. trade policies.
The figures speak volumes: China has enacted an additional tariff of 15 percent on U.S. agricultural exports and added to its unreliable entity list another 10 companies, showcasing an aggressive stance. This retaliation covers nearly $23 billion worth of U.S. goods, a substantial increase from earlier tariffs that impacted only 9 percent of total U.S. imports to China.
Where it sits in our coverage
Currently, we see a consensus target for the USD/CNY pair at 1.075, with a range from 1.04 to 1.12, supported by several firms: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view aligns closely with jpmorgan's stance, which positions itself at the upper end of the range, suggesting overall bullish sentiment around the CNY amidst trade challenges. However, bofa seems to diverge with a more cautious outlook reflecting on economic vulnerabilities.
How other firms see it
Firms like jpmorgan and others are aligned in their expectations, emphasizing a cautious yet optimistic approach towards the Chinese yuan given the current geopolitical climate. Meanwhile, bofa presents a stark contrast, highlighting the potential risks associated with this trade turbulence.
In this context, keep an eye on the USD/CNY exchange rate as it is likely to reflect broader trends stemming from U.S. trade policy and China's response measures.
01China's recent tariff increases signal strong retaliatory measures.
02Emerging markets are becoming increasingly sensitive to U.S. trade policy changes.
03The upcoming months may show volatility as markets adjust to China's trade strategies.
04January statements from the National People's Congress could further influence market conditions.
Market implications
Market participants should closely monitor the USD/CNY levels, particularly as tariffs take effect. A sustained weakness in the CNY could indicate deeper trade implications, prompting adjustments in positioning strategies.
Risks to this view
Any substantial diplomatic breakthrough between the U.S. and China could invalidate this outlook, especially if it leads to tariff reductions or easing trade restrictions, fundamentally altering the current trade dynamics.
ubs
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. Our focus today will be on the emerging market equities landscape with some specific updates on China, including some domestic developments and the implications of very fluid U.S. trade policy and tariff developments.
Joining us for the conversation today, glad to welcome back Xingchen Yu, Emerging Markets Strategist for the Americas with the UBS Chief Investment Office. Xingchen, as always, thank you for dropping by. Nice to be with you today and do look forward to our conversation.
Glad to be back here. Thanks for having me. To get started, to lay the groundwork a bit, markets have been quite volatile in recent days, reacting to very fluid developments with respect to U.S. trade policy.
So can you tell us how China has responded to the new challenges on the trade front and what do you make of the market reaction we've seen thus far? Absolutely right. Markets have been volatile.
But just to recall on the facts, right, so President Trump amended the regional executive order March 3rd to double the additional tariffs on China to 20 percent from the initial 10 percent that took or already took effect on February 4th. As a recap, China's retaliation to the first U.S. 10 percent tariff hike mainly included a 10 to 15 percent tariff hike on worth of $14 billion of U.S. goods, which is about 9 percent of the total U.S. imports to China, and also announced export controls on more real earth materials alongside some symbiotic moves on some U.S. companies. For the latest round, China announced tariff increase with additional tariffs as high as 15 percent on U.S. agricultural exports and added 10 more companies to its unreliable entity list.
Approximately, the newly announced retaliatory tariffs covered just below $23 billion of goods or 14 percent of China's imports from the U.S. in 2024, which is, you know, above the 9 percent in the first round of retaliation. But overall, I tend to think these countermeasures are, you know, pretty proportionate, which leaves some space for future negotiations. First, the retaliatory tariffs on agricultural products and processed food announced by the Chinese government today, I mean, actually last week, fell on a much smaller set of goods than the U.S. tariffs across the board tariff on Chinese goods.
So that's one. But the combination of retaliatory tariffs with entity list additions suggests a more coordinated and comprehensive approach by Beijing compared to the 2018 to 2019 U.S.-China trade war. Still, the door for talks is still open, as I mentioned.
And that might only happen after April, when U.S. is supposed to unveil its review on trade agreements and further tariff announcement, potentially. Now, finally, if you look at market reaction, right, from Chinese risk assets, whether it's yuan or Chinese equities, since the new tariff took effect on March 2nd, they have been actually holding up well. I think the reason we were seeing this market resilience by Chinese assets is twofold.
Number one, there was no further trade escalations so far, right, given China's measured responses. And importantly, the U.S. has so far demonstrated a much broader approach than expected when it comes to tariff targets. So when thinking about the tariff announcements against Canada, Mexico, or, for instance, the steel and aluminum tariffs against other trade partners as well.
And second, there is a fundamental reason behind, which is the catch-up development and, frankly, the surge in market attention to China's AI development. Since the rollout of DeepSeek, we have also seen many very impressive open-source large language models coming out of China, for instance, from Alibaba and Tencent and so forth. Earlier this month, a Chinese startup company released the first so-called general AI agent, which is self-proclaimed to be the first universal general AI agent.
So all these developments have so far supported the sentiment of Chinese tech companies. So if we focus in, Xing Chen, on the market response to tariffs, as I alluded to a bit earlier, we have seen some significant volatility over the past few sessions within the U.S. It seems, however, that ex-U.S. markets, including China, year-to-date have done better than U.S. peers if we focus in on China, specifically Chinese tech.
So would you see the outperformance there to continue? Right. That's a very fair observation, Dan.
We did see international stocks outperforming U.S. stocks this year. To us, this is not a super surprising phenomenon, despite, you know, after a almost decade-long U.S. stock outperformance, right? If we extend the time a little bit back to early 2000s, however, the EM, for instance, outperformance was also pretty visible and dominant back then.
So the point I want to try to make is having a regionally diversified portfolio is more important than ever. As for China equity, we think it remains a key component in global equity portfolios, owing to their unique domestic growth driver and also pretty distinct market dynamics, which offers a source of less correlated returns. In the case of China tech, the structural case on AI is still pretty strong.
And policy-wise, Beijing's commitment to AI, including embodied AI and also government initiatives, should also offer some favorable earnings growth prospects over the median term. Now, I have to say, following a more than 30% of rally year today, we do believe that China internet segment has pricing very little downside risk around potential trade escalations or escalation of some non-trade barriers. For instance, thinking about the U.S. investment restrictions, potentially as highlighted in a U.S. presidential memo called America First Investment Policy.
Hence, we think tactically or over a shorter term, it is wise to put some profit and be selective among China internet segment. If we shift away from the markets and now turn to the macro and policy side of the equation, I know China recently unveiled their key government KPI target for 2025. Can you take a moment to share some takeaways from the important National People's Congress meeting?
Definitely. Sure. In the interest of time, I'm not going to mention the exact numbers in target, but I will say a few points.
Number one, the National People's Congress this year delivered no major surprises with in-line economic targets and also fiscal targets. We also believe a supportive tone in enhancing the high-tech ecosystem domestically could be taken as a mild positive, which reflects the government's continued commitment to pushing for tech self-sufficiency amid all these geopolitical tensions. Last but not least, the mild fiscal package and a so far pretty measurable tariff response in our view confirm that China is still opting for a second mover strategy to addressing headwinds.
More policy support will likely come out down the road, but the timing of which might be dependent upon whether tariff headwinds will intensify and hence negatively impact economic data. So before we close out, Jingchen, let's zoom out a bit to the entire emerging market equity space. What's your expectation for 2025 as we look ahead?
And what do you like at the moment among emerging markets? As a whole, we maintain a neutral stance on EM equities. I think the fair outlook is sort of supported by robust structural trends, such as technology investment and the healthy growth outlook, relatively speaking.
However, there are some of the downside risks that is likely to weigh on, in particular, the near-term performance, right? To name a few, trade policy uncertainty under the current administration presents a near-term challenge. Therefore, we anticipate high single-digit total returns by the end of this year in our base case scenario.
Within the region, we like those markets that can offer exposure to some resilient structural growth trends. We think the ongoing capital expenditures expansion, right, by some of the mega-cap companies, technology companies, as beneficial for AI-related stocks, and particularly in regions such as Taiwan. We also like India for its structural opportunities and then likely upcoming earnings pivots.
And outside of Asia, we also continue to like South Africa for its pretty strong reform momentum down the road. Well, Xing Chen, thank you for dropping by Top of the Morning today to keep our listeners current on developments and preferences within EM equities. Do appreciate the timely updates on China specifically and do, as always, look forward to a continuing our conversation at some point soon.
Much appreciated, Dan. To view the latest research.