As a new trade conflict looms between China and the United States, investors are bracing for another turbulent period that could affect the yuan, bond yields, and stock markets in the world’s second-largest economy. The situation is more complex than the 2018-2019 trade war, with the yuan flirting with record lows and China’s financial assets facing a crisis of confidence.
The global economic landscape has shifted significantly since the last trade dispute. While China has reduced its dependence on the U.S. for exports, its economy now faces a host of other challenges. This includes a sluggish domestic demand, a faltering property sector, and rising deflationary pressures. These issues have worsened investor sentiment, raising the specter of significant capital outflows should market conditions deteriorate further.
Yuan Faces Pressure Amid Trade War Threats
China’s currency has already seen a dramatic drop, losing more than 5% against the U.S. dollar since late September. This decline follows the threat of tariffs up to 60% on Chinese goods by former U.S. President Donald Trump. Analysts predict that if President Trump reintroduces aggressive tariffs under a potential second term, the yuan could weaken further, possibly reaching 7.5 or even 8 per dollar by year’s end, up from the current level of 7.35.
In addition to currency depreciation, Chinese government bond yields have reached record lows, with further downside potential as trade tensions compound ongoing economic struggles. The recent rally in government debt may offer some temporary relief, but further tariff hikes could deepen the financial strain. Investors are particularly wary of the effects on sectors like electric vehicles and solar energy, which may benefit from Beijing’s push for industrial self-reliance but are still vulnerable to broader economic headwinds.
A Delicate Balance: Trade Exposure vs. Currency Stability
Despite the significant reduction in China’s export exposure to the U.S. since the 2018-2019 trade war, foreign demand remains essential for economic growth, especially as domestic consumption remains weak. The government is unlikely to aggressively defend the yuan’s strength for fear of undermining the competitiveness of Chinese exports, which are already under pressure from higher tariffs.
China’s cautious approach to fiscal stimulus has also contributed to investor concerns. This reluctance to implement strong economic measures may make it even harder for policymakers to manage the yuan’s depreciation without triggering a broader capital flight.
“I expect the Chinese yuan to play the role of a shock absorber to the higher tariffs that Trump 2.0 will impose,” said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group Ltd. “However, there is a limit to how far the authorities will allow the yuan to weaken. Policymakers have shown a preference for financial stability over exchange rate competitiveness.”
ANZ forecasts the yuan could fall to 7.50 per dollar by the end of this year, while investment director Edmund Goh at abrdn Plc predicts the currency could breach the 7.8 level if tariffs exceed 40%. Should tariffs be set at a lower 20%, the yuan could stabilize around 7.45.
The Trade War’s Intensifying Impact
Some experts predict a more severe outcome. George Magnus, research associate at the University of Oxford China Centre, argues that the yuan could weaken significantly, possibly reaching 8 per dollar, as the trade conflict becomes more intense. “Beijing will probably allow the yuan to drop quite considerably,” Magnus stated, underscoring the heightened stakes in this ongoing trade war.
During the first Trump presidency, tariffs were levied on a wide array of Chinese goods, including steel, textiles, and chemicals, with rates ranging from 10% to 25%. Tariffs on solar panels were particularly steep at 50%. In response, China imposed reciprocal tariffs, targeting agricultural products and automobiles, which sent the yuan below the critical 7 per dollar mark for the first time in a decade. The CSI 300 index of Chinese stocks saw a sharp decline, falling by 32% over the course of the year, before recovering in 2019.
Reduced U.S. Exposure, Increased Vulnerability
Although China has decreased its direct exports to the U.S. — now accounting for just 15% of total exports, down from around 20% in 2018 — the growing threat of higher tariffs could still put significant pressure on the yuan. As the economy remains reliant on exports for growth, further tariff hikes could exacerbate currency volatility.
Safe Haven Assets and Opportunities Amidst Volatility
Against this volatile backdrop, Chinese government bonds remain a relatively safe bet for investors seeking stability. The rush to safe-haven assets, coupled with Beijing’s ongoing monetary easing, has kept yields on Chinese sovereign debt low. Banks such as Societe Generale, BNP Paribas, and Citigroup expect yields to continue to decline, potentially reaching 1.5% by the end of 2025, down from 1.63% currently.
While the Chinese stock market has had a rough start to 2025, with the CSI 300 index 10% lower than it was when the trade war initially began in 2018, there are opportunities in sectors poised to benefit from the shifting economic landscape. These include industries that align with China’s push for greater self-reliance, such as electric vehicles, solar energy, semiconductors, automation machinery, and pharmaceuticals.
“China will continue to be a high-risk investment, but it offers compelling opportunities for skilled traders,” said Liqian Ren, leader of quantitative investment at WisdomTree Inc. “Despite the risks, China remains a value play.”
In conclusion, while the U.S.-China trade relationship may be shifting once again, investors will need to carefully navigate the potential pitfalls. The yuan, government bonds, and certain stocks could offer opportunities, but they come with increased volatility and uncertainty. As the geopolitical landscape evolves, the ability to assess risk and seize opportunities in China’s shifting economy will be crucial for investors.
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