Dollar Wins amid New China Talks but Price of Progress Could be Too High for Trump

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- USD bests all in G10 other than the CAD on hope of trade truce.

- But preconditions on both sides may derail talks to end trade war.

- China wants new September tariffs scrapped to continue with talks.

- Friday final trading day before September 01 implementation date.

The Dollar rose broadly Thursday amid renewed hopes the U.S. and China will return to the negotiating table but the apparent price of a de-escalation in the trade war could yet prove too steep for President Donald Trump, so markets may ultimately have set themselves up for disappointment. 

China's Ministry of Commerce said in a press conference that its officials have in fact been in contact with their U.S. counterparts and that a delegation will go to Washington next month to discuss the trade conflict between the world's two largest economies, in an apparent contradiction of the official line from earlier this week. The comments prompted a bid for so-called risk assets including stocks, commodities and commodity currencies. 

"The trade team of both sides has maintained effective communication.The two sides are discussing the issue with the Chinese economic and trade mission to the United States in September," an official told The China Daily. "At present, the most important thing is to create the necessary conditions for the continuation of consultations between the two sides."

China previously denied President Trump's Monday claims that it had sought fresh talks ahead of a September 01 deadline that will see tariffs begin to be placed on all of its remaining annual exports to U.S., with the process set to complete on December 15. Trump announced the tariffs earlier in August due to an absence of progress in talks over "unfair" trading practices, only he's since increased the rates charged in a tit-for tat response to China's retaliation.

"Some calm comments from China’s ministry of commerce is igniting a broad “risk-on” bid to global markets this morning," says Eric Bregar, head of FX strategy at Exchange Bank of Canada. "There’s not a whole lot of new “news” here in our opinion, or detail for that matter, but we think we’re seeing a “risk-on” bid this morning because markets are yearning for any sort of positive headline on the US/China trade war front."

Above:Pound-to-Dollar rate at hourly intervals, with EUR/USD (orange) and AUD/USD (aqua green).

Thursday's remarks suggest the world's second largest economy is in fact attempting to avoid the September escalation. However, a closer look at the comments also reveals what looks like an attempt to impose preconditions on the White House if any talks are to continue.

The precondition appears to be that unless Trump is prepared to cancel the tariffs announced earlier in August then China might altogether abandon talks aimed at finding a negotiated solution to the tariff fight. China has long insisted the U.S. remove all tariffs imposed on it, but abandoning talks would be bad for markets, especially 'risk' assets like stocks and currencies like the Australian as well as New Zealand Dollars.

"This weekend will see the US and China both start to impose a new set of tariffs on each other’s goods despite the general bonhomie on trade," says Michael Every, a strategist at Rabobank.

China has repeatedly said it won't cave to U.S. attempts at strong-arming it into any agreement, which is an intention that Trump has publicly acknowledged. China has insisted the U.S. approach it "on the basis of equality and mutual respect". Many have speculated that Trump's trade war is more about preserving American hegemony in the geopolitics and the international economic order than it is about whether or not trade practices are "fair". 

Above: Dollar Index at daily intervals with VIX 'fear index' (orange line, and righthand left axis).

"The requirements stated by both parties as conditions to advance negotiations [removed] are fundamentally incompatible." says Alvise Marino, a strategist at Credit Suisse. "Rising evidence of a negative impact in local data suggests that both parties still view the risk of a severe deterioration in growth as a more palatable option compared to the loss of face and of political capital that taking a step back would imply." 

It's far from clear whether the White House would be willing to further delay the new tariffs not only because the implementation timeline has already been extended once but also because it might cast Trump in a desperate or weak light ahead of an election year when he's claimed so many times the trade war is going well. The implication is that the White House might reject China's preconditions by going ahead with the September tariffs, which could then lead the good mood apparent in markets on Thursday to quickly evaporate.

Last week's tit-for-tat exchange dealt a blow to the Dollar, but the greenback has been inconsistent in its responses to bouts of increased tension. Sometimes it's done well off the back of new tariff announcements seemingly due to its safe-haven appeal and the fact U.S. interest rates are the highest in the developed world, but other occasions have seen it crumble. Thursday saw it rise against all G10 currencies other than the Canadian Dollar.

"Beijing seems to act in a much targeted manner, indeed. Some have concluded that the Chinese strategy is to spoil Mr Trump’s re-election chances next year," says  Yves Bonzon, head of investment management at Julius Baer. "The US ammunition to hurt China is far from exhausted, and one could imagine seriously damaging measures, such as a ban on accessing US capital markets."

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