Against the backdrop of rising uncertainties around China-US trade negotiation, we once again choose to present our macro forecast under a scenario-analysis framework. Since the publication of our 2019 macro outlook in November 2018, the China-US trade negotiation has evolved in a zigzag pattern, before landing somewhere in between our then “baseline” and “bear-case” scenarios. In this report, we update our macro forecasts to reflect these developments, and provide an updated view on potential policy responses under different outcomes of ongoing trade negotiation.

Our baseline scenario largely assumes no further escalation of trade tariffs from their current levels. On the policy front, China will likely stick to the long term goal of “structural deleveraging”, combined with measured counter-cyclical efforts to soften its impacts. Meanwhile, the Fed may cut interest rate by 25bp in 2019. In the more optimistic case, the US may revoke the 25% additional tariff on US$200bn of China exports. In this scenario, however, China’s domestic monetary policy may become more prudent and the Fed may avoid cutting rates this year. In the bear case, the US may levy 25% additional blanket tariff on all China exports to the US, which will severely dampen growth in the China, US, and the rest of the world. In response, both fiscal and monetary policies will likely loosen more aggressively in China, while the Fed may also cut rates more rapidly (50bp this year and more in 2020).

Under our baseline scenario, we expect China’s growth to be maintained at 6.2% YoY in 2019, and slide to 6.0% YoY in 2020. Nominal GDP may expand by about 8% in 2019 and about 7.5% in 2020, with CPI meaningfully outperforming PPI. In the bullish case, real GDP growth may stay at 6.3% YoY in both 2019 & 2020, while nominal growth is expected to stay above 8%YoY in both years. In the bearish case, China’s real growth may dip below 6% YoY in 2H2019 and fall further in 2020; nominal growth will struggle to meet 6% YoY in 2020, despite more forceful counter-cyclical efforts.

Interestingly, the relative contribution to growth from domestic demand (consumption + investment) and net exports may vary widely, depending on the evolution of China-US trade negotiation and the anticipated policy responses. We expect greater relative contribution from net exports to growth under a more benign scenario for China-US trade policies, combined with weaker domestic demand growth due to more deleveraging-oriented regulatory changes – while the opposite may be true if the negotiation goes sour.

We see the risks to our baseline scenario to be balanced at this juncture. USD/CNY may manage to stay just below 7.00 in the base case. We see USD/CNY trading at 6.98 by the end of the year assuming the “status quo” on trade talk, while it may swing to 7.18 under the bear case, and appreciate to 6.78 in the more upbeat scenario. It is also worth noting that with US growth momentum softening at a rapid pace and US interest rate higher than most developed countries, we see limited upside to the US dollar in 2019-2020.