China seen allowing the yuan to depreciate materially as trade war escalates

Investing.com -- Chinese equities are coming under renewed pressure as BCA Research warns that authorities are likely to let the yuan depreciate significantly in response to escalating trade tensions with the U.S.

Beijing is viewed as unwilling to make major concessions after a steep increase in U.S. import tariffs.

“We believe Beijing's top leadership views U.S. tariffs as nothing short of a declaration of economic war, not just a trade dispute,” Arthur Budaghyan, Chief EM/China strategist at BCA Research, said in a report.

With tariffs now at 125%, BCA argues that “there is no feasible way to mitigate the additional 114 percentage point increase in tariffs since the beginning of the year.”

A substantial weakening of the yuan could weigh heavily on emerging market (EM) currencies and equities.

The report notes that EM exchange rates tend to correlate with the yuan and recommends shorting the CNH versus the dollar.

For equity investors, the strategists downgrade Chinese offshore stocks from Neutral to Underweight, citing increased vulnerability to both capital outflows and potential U.S. divestment orders.

“Chinese offshore stocks will drop considerably,” strategists write, adding that global and EM risk assets are likely to “resume their downtrend after the rebound.”

The market research firm also sees risks that Washington may instruct U.S. investors to exit positions in Chinese stocks and bonds, making offshore shares more exposed than their onshore counterparts.

Currency devaluation is seen as both an economic and political response. Beijing is expected to frame the move as a defensive strategy in support of exporters, appealing to nationalistic sentiment to avoid triggering panic or capital flight.

BCA forecasts a depreciation of 8-10% in the CNH against the U.S. dollar over the next six months, and notes that the People’s Bank of China (PBoC) may further lower interest rates as a result.

“Such devaluation will not be enough to help mainland exporters that sell to the U.S. However, it will help Chinese exports gain market share outside the U.S,” the strategists noted.

From a domestic political point of view, BCA believes China is in a stronger position than the U.S. to endure short-term economic and financial setbacks in pursuit of longer-term strategic and economic objectives.