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Trade War Panic Sends Oil Lower

Nick Cunningham

Oil prices fell sharply on Tuesday as fears over the economic fallout from the U.S.-China trade war returned.

On Sunday, a 15 percent tariff on roughly $112 billion worth of Chinese goods took effect, and retaliatory tariffs by Beijing on American goods also went up. Trump had previously decided to hold off on putting tariffs on a much larger $300 billion tranche of Chinese goods – the remaining levies are set to take effect in December. Together, the tariffs could impose the equivalent of a $1,000 tax on American consumers over the course of a year.

Financial markets showed a renewed bout of concern as the summer draws to a close. On Tuesday, major stock indices were down sharply, as was crude oil. While the higher tariffs were bad enough, markets saw deeper gloom because trade negotiations seemed to be in worse shape than previously thought.

Softer rhetoric from Trump and Beijing last week helped lifted spirits, although it’s a bit of a mystery why financial markets take shifts in tone at face value, as if they offer concrete evidence of anything in particular. After all, the tone of Trump’s twitter feed changes by the hour.

More importantly, both sides have dug in hard on the trade fight, and with each passing round it becomes harder to find a face-saving way for either Trump or Xi Jingping to exit the standoff. After all, both have powerful reasons not to back down, despite the economic toll.

It shouldn’t be surprising then that the talks are faltering before they even started. “We’re going to win the fight,” Trump told reporters. “We’re having conversations with China, meetings are scheduled, calls are being made. I guess the meeting in September continues to be on, it hasn’t been canceled,” he said.

Yet, Bloomberg reported that Chinese and American officials can’t even manage to agree on a schedule to hold the negotiations. That doesn’t mean that the talks won’t happen, but if the two sides are at odds over how to restart talks, it does not bode well. And because financial markets were encouraged last week based on the questionable notion that the U.S. and China were eager for a deal, the latest snag over scheduling is a grim reminder that the trade war is very far from a conclusion. 

The scheduling mess added to the market’s woes. Also, China submitted a trade complaint to the World Trade Organization over the U.S. tariffs at the start of the week.

Against this backdrop, Trump’s harsh rhetoric towards China returned on Tuesday, once again underscoring the hollow foundation that last week’s rally was built upon. “Think what happens to China when I win,” Trump said in a tweet on Tuesday, referring to the 2020 presidential election. “Deal would get MUCH TOUGHER!”

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A string of recent economic data also poses reasons for concern. The Institute for Supply Management’s purchasing managers index fell to 49.1 in August, dipping into negative territory. A reading below 50.0 signals a contraction. This means that U.S. manufacturing activity contracted for the first time since 2016, while a measurement of new orders is at a seven-year low.

Several analysts cut their growth forecasts for China as the trade war continues to inflict damage. Oxford Economics, Bank of America Merrill Lynch and Bloomberg Economics all cut their GDP forecasts for China to below 6 percent.

With traders spooked, the dollar rose to its strongest level in over two years and the yuan weakened to about 7.2 to the greenback, the weakest level since the global financial crisis more than a decade ago. A stronger dollar and weaker yuan poses further risks to global growth. Other emerging economies are coming under enormous pressure to weaken their currencies as a result. Taken together, crude oil becomes significantly more costly in this currency race-to-the-bottom, another headwind for crude oil prices.

Meanwhile, a Bloomberg survey estimates that total OPEC production actually increased in August by 200,000 bpd, with gains from Saudi Arabia, Nigeria and Iraq. Russia also boosted output by 100,000 bpd – pushing production higher than its agreed upon threshold as part of the OPEC+ deal. “To protect the oil price from another slump, considerable production discipline will be needed from OPEC+ in view of the fears about demand,” Commerzbank said in a note.

By Nick Cunningham of Oilprice.com

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