The economy is cooling, and policy makers are taking steps to calm jittery global markets as the trade war with the United States escalates.

In China, things are getting interesting. It’s clear the economy is slowing. While the data is not of the highest quality and it’s hard to be confident about the exact space of the slowdown, we believe the slowdown is real. Whether you look at the famed Li Keqiang index (LKQ), the various PMIs, or our nowcast, the only questions are about the speed of the deceleration and how broad it is. Another sign of the downturn is that the Politburo issued a statement in October saying, “timely steps are needed to counter the slowdown.”

It’s unusual to see that kind of declaration. There are three things going on here. The first is that policy makers continue to attach importance to deleveraging the financial sector. The second is the trade and investment conflict with the United States, which has increased uncertainty for the business sector in China. The third is that as the Chinese economy gets bigger and more complex, it gets harder for the authorities to fine-tune its performance. This combination of pressures increases the risk of policy overshoot, and the fact that the trade conflict is an external shock of unknown dimension adds to the difficulty.

Weakening yuan and policy tools

There is one obvious release valve — the exchange rate — and it has weakened. But there is a risk that allowing the yuan to weaken too far, or too quickly, would destabilize private sector expectations and create more macroeconomic problems than it solves. There are some signs that capital outflows are picking up. In the very short term, the yuan is likely to move with the trade war prospects: The currency will weaken on tariff threats but strengthen after phone calls between Trump and Xi Jinping. The other easily available fiscal tool is infrastructure spending. But the problem is this operates with more of a lag and is less useful. Of course, Beijing could give up on fine-tuning altogether, but it doesn’t seem willing to do that. So far, the government has revealed little about new policies to counter pressures on the economy.

There is a risk that allowing the yuan to weaken too far, or too quickly, would create more macroeconomic problems than it solves.

No sign of a trade deal

The other obvious possibility is to reach a trade agreement with the United States to lift the cloud from the Chinese economy. There are Trumpist economists who argue U.S. measures have weakened China’s economy, and that if Trump continues to push hard, he will force China to the table with fresh concessions to reach an agreement. We are skeptical about this strategy and its chances for success.

China’s growth trends lower (% quarter-on-quarter)

It takes two to reach an agreement. It is not really clear what Trump and his advisors want, and it’s not at all clear that Beijing is ready or willing to submit. But there are times when the smoke signals seem more or less encouraging. China is increasingly of the view that there will be no trade deal and that rebalancing the bilateral trade position by importing more goods from the United States is simply not going to work because the real goal of the Trump administration is to weaken China and reduce its integration into the global economy.

The “cheese option”

If this does become the dominant view in Beijing, then the chances of a trade agreement shrink. Moreover, even if there is a benign eventual outcome, the short-term risks are clearly biased toward things getting worse. There is, of course, the good outcome that, in honor of the tiny concession Canada made to be able to join the new NAFTA, we call the “cheese option.” Under this scenario, the United States accepts what it previously rejected. We can’t rule this out. If the U.S. economic outlook deteriorates, this option would become more appealing to the White House. But we don’t expect such an outcome given the anti-China trade warriors in the administration.

China is likely to be successful in shepherding its economy to a growth rate policy maker it is happy with. But downside risks loom large. The economy’s path isn’t exactly what Beijing wants or planned. Our confidence in their ability to get what they want has slipped. There is also the risk that, if the U.S. administration believes that an ever-tightening screw is the way to wring concessions out of Beijing, the screw may get overtightened. This would raise the risk of a sharper Chinese downturn. Given the economy’s weight in global trade and global GDP, a sharp slowdown would matter for overall growth prospects.

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Global economic growth remains vulnerable in the face of escalating trade tensions, higher interest rates, and volatility among emerging markets.