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June 2020 / INVESTMENT INSIGHTS

Five Dimensions to Watch Amid U.S.-China Tensions

How rising U.S.-China tensions could unsettle markets

Key insights

  • Tensions are rising with U.S. President Donald Trump using a “blame China” strategy as the centerpiece of his November reelection campaign.
  • Further escalation in U.S.-China tensions is possible, with the U.S. elections coming up in November.
  • January’s trade truce between the U.S. and China is at risk.


Tensions between the U.S. and China have ratcheted higher lately as U.S. President Donald Trump has made blaming China the centerpiece of his November reelection campaign. This has manifested into a range of threats and action from the U.S. in recent weeks. China has broadly responded with proportionate measures, though some actions taken recently have further inflamed the situation. Further escalation in tensions is possible as the election date nears. This could have implications for financial markets, so understanding the different dimensions of the tensions and the risks involved is important.

Here we highlight five key areas investors need to watch over the coming months.
 

For financial markets, the trade deal collapsing poses the biggest danger.

Trade Deal—January Agreement Under Threat

President Trump has threatened to walk away from the trade deal signed in January, leading officials in China to threaten the same. The risks of the deal breaking have clearly risen. Let’s not forget that the trade deal’s biggest achievement was putting a restraint on further tariff escalation. Therefore, in the scenario where the truce doesn’t hold and the U.S. walks away first, it’s possible that existing tariffs on imported goods will be raised further. In response, China might decide to weaken the renminbi. For financial markets, the trade deal collapsing poses the biggest danger.
 

Five Key Areas to Watch Over the Coming Months

Five Key Areas to Watch Over the Coming Months


Technology—Ambition and Security Concerns Collide

Technology is an area of great competition between the two countries. While the U.S. seeks to maintain its position as a leader in technology with less reliance on China in the supply chain, China is striving to become more self-sufficient and a future tech powerhouse. The recent step-up in tensions on this front is related to Chinese telecommunications giant Huawei Technologies. Last month, the U.S. announced tighter restrictions on the ability of Huawei to use U.S. technology or software design in the manufacture of its semiconductors outside the U.S.

Technology is an area of great competition between the two countries.

The new rules, which are scheduled to come into effect this September, will apply some pressure, but it’s unlikely that the U.S. Commerce Department will make them so tight as to be highly disruptive. China’s options to retaliate on tech in the near term are limited. Medium term, the goal is self-reliance, and China’s government continues to invest in building an indigenous chip capacity that can compete at the frontiers of tech.
 

Financial—Tighter Constraints on Access to International Finance

There have been a few developments on this front lately. Of particular note was the U.S. Senate passing a bill that could stop some Chinese companies from listing shares on U.S. stock exchanges unless they adhere to certain U.S. accounting regulations, such as for audits. This has the potential to affect some of China’s tech giants, although they could shift their listings to other places, such as Hong Kong. The bills also currently propose that any delisting would not happen until 2025 (or that there would be a three-year grace period for China to reach agreement on compliance with the regulations), so companies would have time to relocate listings or put in place the measures needed to comply.

Separately, the U.S. Federal Retirement Thrift Investment Board, which manages government retirement funds, walked away from plans to invest in Chinese stocks this year following heavy pressure from the Trump administration. This is a symbolic move, but it is not expected to have a significant immediate financial impact on China. What could be more meaningful is if other public pension plans at the state and local levels in the U.S. also come under pressure to exclude Chinese securities. So far this doesn’t appear to be the case, but it’s important to monitor.
 

U.S. Congress—Raising the Geopolitical Stakes on a Range of Issues

Congress is considering a number of anti-China bills that cover a wide range of topics, including a coronavirus responsibility act, stripping China of sovereign immunity against lawsuits, and new bills on Xinjiang and Tibet, as well as others. Here, it’s important to watch whether bills that pass make punitive actions mandatory or allow the executive latitude to decide how to impose any penalties.
 

Strategic Relationships—Tensions in Hong Kong Take Center Stage

Here it’s important to monitor developments in Hong Kong, Taiwan, and South China Sea. What has garnered a lot of attention recently is Hong Kong. In response to China proposing to move ahead with a national security law for the territory, the U.S. announced that it no longer considers Hong Kong autonomous from China. As a result, the U.S. could impose a range of measures, including targeting sanctions on Chinese officials and removing Hong Kong’s special trading status. As Hong Kong’s exports are relatively small, the latter is manageable.The stakes turn higher if the activities and movement of top-level officials are targeted or if sanctions are imposed on Chinese financial firms. Indications are that the measures won’t go that far, which is encouraging.

In the South China Sea, the U.S. continues to push its naval patrols while China continues to build its presence and target ships from other countries. These naval maneuvers have not led to any major incidents, though the possibility cannot be discounted.

With respect to Taiwan, the U.S. continues to support the government in a high-profile way. Most of these acts are symbolic but in a way that appears to edge toward treating Taiwan as de facto independent, which is a clear red line for China. The current Taiwanese government, while advocating for independence as a long‑term goal, is not inclined to escalate the situation right now with any such declaration.

Monitoring these five factors will be important as the U.S. election campaign intensifies over the coming weeks and months. Further escalation and deterioration in any of these areas has the potential to impact investor sentiment and ignite volatility in financial markets.

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