From Boris Schlossberg: Although equity markets remain near all-time highs, the sense of unease among investors is almost palpable. And while stocks are still bid, other markets like bonds and currencies are considerably less bullish than just a month ago.

The dollar especially has been hit hard with USD/JPY dropping below the key 112.00 level yesterday, triggering concerns that the massive rally since Election Day may have topped.

What’s creating all the angst?

The primary cause of all the concern is the prospect of a much more protectionist policy by the Trump administration. A recent report by Goldman Sachs analysts Andrew Tilton and Alec Phillips suggested that: “We believe the Trump administration is likely to make an announcement on China’s currency policy and impose unilateral tariffs on a number of products. In general, we expect this administration to be much more active in using existing ‘trade enforcement’ tools than recent administrations.”

Peter Navarro, President Trump’s trade adviser, proposed a 45% tariff on all Chinese-made goods. Such a move would essentially blow up the current economic world order and would no doubt lead to a trade war. Indeed, Chinese officials have stated that even a 1% tariff on goods would trigger a very aggressive response from China.

No one expects such radical policy moves to become a reality, but it is clear the Trump administration will be much more aggressive at enforcing the current trade rules than President Obama was. Although the Chinese are understandably upset at the current rhetoric coming from the Trump administration, they are in a far weaker negotiating position than they were just several years ago.

China’s GDP growth has slowed markedly from the 10% pace of a few years ago. The country is facing a demographic time bomb with its aging population. It has massive overcapacity in real estate and industrial production sectors, and perhaps most importantly, it is seeing huge capital outflows from the country. China has lost more than US$1 trillion of foreign currency reserves from its peak of more than US$3 trillion just a few years ago.

The much-vaunted threat of China selling their portfolio of U.S. sovereign bonds would likely hurt the Chinese more than the U.S. at this point. That’s because investors – and in a worst-case scenario, the Fed – could easily step up and purchase the securities and leave the Chinese in an even worse capital account position.

President Trump understands this situation well. He is a master at exploiting his opponent’s weaknesses. And all of the current posturing may simply be an opening gambit for establishing more favorable terms of trade between China and the U.S. Perhaps the most insightful quote about Mr. Trump comes from himself. When asked in a 1990s interview if there was some master plan that he followed in deal making, Mr. Trump stated that, “It’s much more improvisational than people think.”

There is no doubt that the Trump approach to almost every area of policy-making has been much more improvisational than his predecessors. Yet markets crave stability. Investors despise chaos, and businesses require a clear understanding of the landscape before they commit to investment decisions.

That’s why President Trump’s approach – even if it is successful in the end – could roil markets in the near term, especially if the rhetoric on trade and exchange rates ratchets up once again.

The iShares FTSE/Xinhua China 25 Index ETF (NYSE:FXI) rose $0.52 (+1.41%) in premarket trading Wednesday. Year-to-date, FXI has gained 5.93%, versus a 2.42% rise in the benchmark S&P 500 index during the same period.

FXI currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 32 ETFs in the China Equities ETFs category.

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This article is brought to you courtesy of Money And Markets.

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