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China's Likely Retaliation to US Tariffs & Its Impact on ETFs

Sanghamitra Saha
Possible retaliatory ways of China against Trump administration's claims of imposing tariffs on about $505 billion of goods and its ETF impact.

We are now past the half-way mark of 2018 and trade tensions show no signs of slowing. The United States and China first targeted $50 billion worth of goods for import tariffs, then the Trump administration disclosed another list of tariffs on $200 billion worth of Chinese goods. Now President Trump intends to enact tariffs on all $505 billion of Chinese goods imported into the United States – the dollar value of U.S. imports from China in 2017.

Now the question is, to what extent China can retaliate? Chinese import from the United States is only $130 billion worth of U.S. goods. So, a tit-for-tat tariff of equal measure is not possible. Still there are some ways which can be utilized by China to counter act, per an article published on CNBC.

Yuan Devaluation

Per a multi-asset investment manager, “currency is the most effective lever to offset the impact of tariffs,” as quoted on CNBC. If the yuan drops about 8%, U.S. companies would have to experience only a 2% jump in importing Chinese goods. This is because a lower yuan would reduce the cost of imports to U.S. companies and any add-on tariffs on the price tags would keep the after-duty price almost at a level where it is now.

In fact, the world has started speculating that China might be considering a deliberate devaluation in yuan. The offshore yuan’s one-week implied volatility already spiked to a five-month high, per Bloomberg. The People’s Bank of China weakened the yuan-greenback reference rate the most in two years. WisdomTree Chinese Yuan Strategy ETF CYB has been down 6.3% past three months and off 3% in the past one month (as of Jul 22, 2008) (read: Guide to China Yuan ETF Investing).

Targeting the U.S. Treasury Market

China is one of the biggest holders of U.S. Treasury’s, possessing about $1 trillion of bonds in 2017, according to the Federal Reserve. If China chooses to offload its holdings or stop buying new U.S. bonds, U.S. treasury yields would rise, resulting in a drop in bond prices.

The situation can turn more problematic given the Fed is also on a policy tightening mode and treasury yields are on the higher side this year. iShares 20+ Year Treasury Bond ETF TLT will come under pressure in such a situation.

Higher treasury yields would make new debt issuances for the U.S. government costlier. However, chances of such moves are less likely as “”it would make China's own holdings lose value and there’s no good safe alternative for their dollars,” per CNBC.

Hitting U.S.-Based Companies Hard

Per an article published on CNBC, some U.S. sectors have the highest revenue exposure to China and are thus more susceptible to the trade war. These sectors are the likes of semiconductor, energy, auto and tech hardware and equipment.

Per Morgan Stanley equity strategists, “semiconductor and semiconductor equipment companies have the highest revenue exposure to China at 52%” and are thus exposed to maximum risks on rising trade tensions. So, companies like iShares PHLX Semiconductor ETF SOXX should be watched closely (read: 5 Sector ETFs Most Exposed to Trade Tensions).

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