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Rating China's retaliation in the trade war: 'On a scale of 1-10, it's an 11'

Key Points
  • Wall Street analysts warn that the U.S. trade war with China has escalated significantly and will likely intensify in the coming months.
  • This is "a new and potentially more volatile phase," Compass Point told investors.
  • China's response to new U.S. tariffs is "designed to get the President's attention," Cowen says.
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Wall Street analysts warned investors to brace for the trade war between the United States and China to further intensify, after it ratcheted up over the weekend to a level that Cowen says, "on a scale of 1-10, it's an 11."

"Overnight, Chinese government retaliated against new U.S. tariffs, and it's designed to get the President's attention," Cowen analyst Chris Krueger said in a note to investors Monday.

A Morgan Stanley team of analysts said, "investors should behave as if further escalation will happen in 2019." If that escalation does come, the firm estimated that a global economic recession will come in the next nine months.

"We take its literal message of planned tariffs quite seriously. There's a pattern of responding to insufficient negotiation progress with escalation," Morgan Stanley said.

This is "a new and potentially more volatile phase," Compass Point analyst Isaac Boltansky said, adding that China's response "marks a pronounced escalation in trade tensions between the world's largest economies."

Chinese President Xi Jinping stands by national flags.
Johannes Eisele | AFP | Getty Images

China responded on Monday in two ways to President Donald Trump announcing the U.S. will add 10% tariffs to $300 billion worth of Chinese goods.

First, China's central bank allowed its currency the yuan to fall "below 7 to the dollar, which is a psychologically significant threshold," Krueger said.

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The People's Bank of China, the country's central bank, denied it is intentionally devaluing its currency to counter tariffs. The bank said the drop was "driven and determined by the market." But China has historically controlled its currency and, on Monday, the yuan declined to its lowest level against the dollar since 2008.

"While the currency had been weakening recently, the sharp move ... clearly signaled a change in policy and will be interpreted as a signal the Chinese are not seeking a near-term deal," Krueger said.

Second, Krueger noted that the Chinese told state-controlled buyers "to halt all purchases of U.S.agricultural imports. "

"It looks like those rotting soybeans will continue to rot, and is a tough hit to Midwestern (Trump states) farm interests after the President promised relief," Krueger said.

Trump claimed in June that Chinese President Xi Jinping had agreed to large amounts of agricultural purchases. Additionally, the Trump administration last month announced details of a $16 billion aid package for U.S. farmers.

But Trump says the new 10% tariffs are the result of Xi not making those purportedly agreed upon purchases. Although China claims it's not true that it halted buying agricultural products, Bloomberg News reported that Beijing intends to wait and see how trade negotiations play out before it makes any purchases.

On top of those two responses, Krueger also said China may clamp down on the companies operating within its borders.

"There is increased anecdotal evidence that the Chinese government is tightening its overview of foreign firms, including through creation of a 'undesirable entities' list and practices," Krueger added.

Overall, analysts don't believe the situation will de-escalate or be resolved quickly, either. Boltansky said that "odds favor some form of trade détente prior to the 2020 election, but trade relations with China will almost certainly worsen before a political pause can be crafted."

"If China remains steadfast, the US administration's instinct is to escalate," Morgan Stanley added.

– CNBC's Michael Bloom contributed to this report.