The rising tensions between Washington and Beijing could become a more persistent headwind for markets, as the issue of China becomes a larger focus in the U.S. presidential election.
So far, the war of words between the countries over blame for the coronavirus, the U.S. crackdown on Huawei and now Chinese companies listing on American exchanges have not had a major impact on the Wall Street stocks. But in the last two sessions, the countries' relationship has hung over the market, especially as China announced new security measures for Hong Kong on Friday and took the unusual step of withholding its GDP forecast because of the virus impact.
The U.S. this week also announced the sale of $180 million torpedoes to Taiwan, further aggravating the relationship with Beijing, which views Taiwan as part of greater China.
Global stock markets declined Friday and Hong Kong shares fell sharply as China's poor economic outlook and the prospect of a new security crackdown by Beijing on Hong Kong stirred fears.Â
Strategists have been watching the weakening of the Chinese yuan against the dollar as an early warning signal of a potentially broader market reaction, and it is getting close to levels it was at during the height of the trade war in the fall of 2019. The yuan was weaker at 7.133 to the dollar Friday.
"I think our own election cycle is going to keep it at a very high decibel," said Marc Chandler, chief market strategist at Bannockburn Global Forex. He said the slide in China's currency has been a soft warning that China is unhappy with the actions of the Trump administration. Beijing sets the value of the onshore currency each day.
Strategists expect the U.S. to continue to focus on strengthening laws to curb China's ability to obtain American technology and invest in strategic industry, and they see bipartisan support for a chillier relationship with China that could lead to further decoupling of the world's two largest economies.Â
"China is about two months ahead of the U.S. on the coronavirus. They see the United States as hobbled by our coronavirus problem," said Daniel Clifton, head of policy research at Strategas Research. "We have an upcoming election, which is paralysis for the political system. They are using this as an opportunity to be aggressive toward Taiwan and Hong Kong."
As China's National People's Congress met Friday, details of a new security law intended to tighten Beijing's control over Hong Kong were released. The legislation is expected to prompt protests by the pro-democracy forces in Hong Kong and strain relations even more between the U.S. and China. Hong Kong shares sold off 5.6% Friday.
President Donald Trump has punctuated the disputes with tweets including one on Wednesday, where he said China's "disinformation and propaganda attack is a disgrace." Trump has blamed China for concealing information about the spread of the coronavirus, which first appeared in Wuhan late last year and has now killed nearly 100,000 people in the U.S.
One concern among market pros is that the U.S. and/or China would resort to a new wave of tariffs that could be hard on both economies, which have become more fragile as a result of the coronavirus.Â
"The problem now is the global economy was much better when we had this tariff stuff before and was able to absorb it, and now we're much less able to absorb it ," said Peter Boockvar, chief investment strategist at Bleakley Advisory Group. Boockvar said Trump is listening to his hawkish advisors like trade advisor Peter Navarro. "Trump is acting out and deflecting and blaming ahead of the election about who got us into this pickle. China is now the archery target for this virus and Trump is going to let the world know: 'It wasn't me, it was them.'"
But political strategists say the friction with China is not just about the election, though it will certainly play in the political arena. Cornerstone Macro strategists say there's bipartisan support for reconsidering the U.S. economic relationship with China, and that the Trump administration's efforts to tighten rules denying China access to critical technology and limit its investment will continue no matter who wins the November election.
They note that Trump expects to run on themes that he can rebuild the economy and that he will be tough on China, while his opponent, former Vice President Joseph Biden would not be.
"But Trump is running against China for a reason: it's increasingly a pariah with the American people," the Cornerstone strategists wrote. "China wasn't even popular before the coronavirus, which is one reason we argued since Trump was elected that he was likely to follow through with his threats to raise tariffs." They said Trump could raise some tariffs modestly before the election but would take a much harder line if he is reelected.
Clifton said it appears the Chinese currency move is signaling the trade deal could unravel, but the new less-friendly atmosphere is not really about the trade agreement. "Trump is actually now saying I don't care if I have a 100 trade agreements. This relationship is wrong," he said. "Trump is moving to decouple us from this relationship faster than people think."
 Clifton said the rift with China is bigger than people anticipate, and Trump is being forced into taking a more aggressive stand. "China is forcing him into it. The election is in front of us. Public opinion has really turned on China," he said. "Public opinion has really shifted here so Biden is now adopting a more hawkish tone to China."
Chandler said he expects Democrats would try to create a coalition with other nations over its objections to China's behavior, while the Trump White House has a more unilateral approach.
Biden, in fact, told CNBC Friday that the U.S. should not be silent on Hong Kong, and if he were president he would take the matter to the United Nations. "We have governed not merely by the example of our power, but by the power of our example...and we should not remain silent. We should be calling on the rest of the world to condemn their actions."
Clifton said China is adhering to the phase one trade agreement, which had been intended to be interim. He said the deadlines have all been met, and there have not been political issues around the implementation.
"It tells me there's a larger issue here. This is a geopolitical issue here," said Clifton. He called the incidents between the U.S. and China daily "brush fires" that risk becoming a forest fire.
In a report to the National People's Congress on Friday, Chinese Premier Li Keqiang vowed that Beijing will work toward the liberalization of global trade and investment. He specifically acknowledged that China will work with the U.S. to implement the phase one trade deal.
But longer term, trade may take a backseat to a reshaping of how the U.S. sources things like technology and medical supplies.
"One school of thought is the trade deal just dies on the vine," Clifton said. "It's really about foreign investment. It's really about putting pressure on supply chains. That's where you're going to start seeing developments. Everything is going to be about onshoring back to the U.S."
In Washington this week, the Senate passed a bill by unanimous consent that could result in the delisting of Chinese companies. It would require companies to certify that they are not owned or controlled by a foreign government. It would also require the Securities and Exchange Commission to bar trading in any stock where the auditor hasn't been inspected by the the Public Company Accounting Oversight Board for three years in a row.
As for Huawei, the U.S. barred American companies from supplying the Chinese firm a year ago because it believed the firm was engaging in cyber espionage. Last week, it cracked down even further with new rules aimed at Huawei's in-house chips. China is expected to push development of its own industry to supply the telecommunications giant.
"The Huawei dispute is a timely reminder that U.S.-China decoupling appeared increasingly likely before COVID-19. The outbreak has only intensified the trend," Capital Economics' Julian Evans-Pritchard said in a note. He said China has increased support for its producers, which are trying to catch up with foreign rivals, but that could take years and Huawei will have a more difficult time competing globally.
China's response, to double down on state-led industrial policy "risks weighing on productivity growth further given the state's recent track record in allocating resources efficiently," he said.