While I have never been in a real hurricane — I’ve only gotten hit by the remains of several as they moved up the East Coast — they say that the very middle (the “eye”) of the storm is remarkably calm.
Those who have been unfortunate enough to get a direct hit actually get a reprieve in the very middle of the storm, as the weather calms until the back end of the hurricane wall repeats the devastation that the front end just caused. The eye of the storm provides a false sense of security that “it will all work out somehow.”
We survived imploding volatility exchange-traded products in February, and we have now made all-time highs in the Russell 2000 RUT, +0.16%[1] and the Nasdaq 100 NDX, +0.67%[2] indexes. The stock market is now remarkably calm as President Trump is cattle-prodding the Chinese with his intentional weeks-long delays on announced tariff packages in order to make a deal, and he just gave them an extra week until Sept. 5. His approach has not worked yet, so we have to consider the scenarios, of which there are three.
Three scenarios
The best-case scenario is for the Chinese, and others in a similar situation, to make a deal before the majority of the announced tariffs go into effect. This scenario seems unlikely, based on the present trajectory of trade negotiations and the move of the Chinese yuan, which is experiencing its steepest decline in many years (seen as a move higher on the inverted chart[3]). The Chinese are taking away the gift they gave the Trump administration in 2017 by guiding the yuan to appreciate (the move lower on the chart). At this rate of depreciation, the USDCNY, +0.2931%[4] exchange rate could breach 7 very soon.
While it is overly simplistic to think that the Chinese are devaluing to simply counter a 25% tariff with a 25% devaluation, this sharp reversal is an indication that the yuan is a major weapon in their arsenal to be used in the current trade negotiation. I still think that even with a tit-for-tat devaluation of the yuan for the size of the tariffs, we will have a disruption in Chinese (and perhaps U.S.) economic activity, as it will...