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Why US-China trade tensions are fuelling the bond sell-off

Oct 10 2018 at 9:00 PM Updated 1 hr ago

It's probably no coincidence that long-term US interest rates have spiked to their highest level in seven years at the same time that investors have come to the belated realisation that the Trump administration's tariffs on Chinese-made goods are likely to remain in place for years, which will undoubtedly add to rising price pressures.

At the outset, most analysts regarded US President Donald Trump's tariff threat as a negotiating ploy to force China to open up its markets and commit to buying US-made goods in order to whittle back the $US375 billion ($527 billion) trade surplus it runs with the US.

But it's now clear the Trump administration's gripe with China runs much deeper than the yawning US trade deficit.

The Trump trade team - led by US trade representative Robert Lighthizer - is putting pressure on China to stop what they believe are unfair trade practices.

Beijing, they claim, forces US companies to hand over advanced technology to their Chinese partners, while lavishing huge subsidies on Chinese government-owned firms, giving them a competitive edge in global markets.

Beijing anger at demands
As a result, the US is pushing Beijing to introduce major structural changes to its economy, including reducing the dominance of the big state-owned firms, and stopping the practice whereby US firms are forced to transfer technology to Chinese partners in order to access the Chinese market.

Not surprisingly, Beijing is incensed at the US demands. Earlier this week, China's Foreign Minister, Wang Yi, lashed out at the US president, accusing Trump of "constantly ramping up" trade disputes and finding fault with China's domestic and external affairs "without reason".

As a result, hopes that a high-level meeting between President Trump and Chinese President Xi Jingping at next month's Group of 20 leaders' summit in Buenos Aires might defuse the bristling trade tensions are waning.

Indeed, Washington, which is frustrated at Beijing's refusal to discuss what it sees as unfair trade practices, has reportedly threatened to cancel trade talks between the two leaders unless Beijing comes up with a list of concessions.

As the prospect of an easy and quick resolution of trade frictions faded, bond-market investors, who keep a close look out for rising prices - because inflation erodes the purchasing power of bonds' fixed payments, have taken fright.

Effect of US bond sales
They've been selling US bonds, which has pushed the yield on benchmark US 10-year bonds to 3.2 per cent, around the highet level since May 2011 (yields rise as bond prices fall).

Their concerns about inflation are twofold. Firstly, the US has already imposed tariffs on $US250 billion of Chinese-made goods, including TVs, washing machines, electronics and solar panels.

What's more, Trump has warned he stands ready to impose tariffs on the remaining $US250 billion worth of imports from China.

There's little doubt these tariff hikes will result in higher prices for US consumers and US firms that rely on imported Chinese components. US steel prices have climbed more than 40 per cent since Trump slapped a 25 per cent tariff on steel imports in March.

But a far greater impact will come over the medium-term, as US and other foreign companies shift manufacturing operations out of China to avoid the tariffs that target Beijing.

Currency tactics
Bond investors fear that as more multinationals shift their manufacturing out of the highly competitive Chinese factories, it will put strong upward pressure on the prices of almost all manufactured goods, spurring global inflationary pressures.

Of course, Beijing has been able to mitigate the effect of higher US tariffs by allowing its currency to drop. The yuan has fallen by 10.9 per cent from late March - making it one of Asia's worst-performing currencies over that period. It is now trading at 6.92 per US dollar.

The yuan's sharp decline has triggered speculation China has deliberately weakened its currency to make Chinese-made goods cheaper in global markets, offsetting the effect of higher US tariffs.

But Washington is far from pleased with the yuan's steep decline. In an interview with the Financial Times published Wednesday, US Treasury Secretary Steven Mnuchin pointedly warned China against trying to get a competitive advantage by devaluing its currency.

"As we look at trade issues, there is no question that we want to make sure China is not doing competitive devaluations," he said.

https://www.afr.com/opinion/columnists/why-uschina-trade-tensions-are-fuelling-the-bond-selloff-20181010-h16g0w