Just minutes before the July payrolls report in the U.S, China took things up another notch in the trade war.

In what looks like an effort to get out ahead of things after Donald Trump directed Robert Lighthizer to ponder hiking the proposed tariff rate on an additional $200 billion in Chinese goods to 25% from 10%, Beijing says it will slap “differentiated tariffs” on some $60 billion in U.S. goods, “as soon as” the Trump administration implements its own measures.

According to a statement from the Chinese Finance Ministry (which you can read in full below), the proposed retaliatory measures will take the form of tariffs ranging from 5% to 25% on more than 5,000 types of items.

After expressing its dismay at the U.S. President’s ongoing belligerence, the Ministry lambasted Washington in terms that convey a clear sense of incredulity that’s shared by the rest of America’s trade partners.

“The United States has deviated from the consensus of the two sides on several occasions, unilaterally escalating trade frictions, seriously violating the rules of the World Trade Organization, undermining the global industrial chain and the free trade system, substantially harming the interests of our country and people,” the Ministry says, adding that eventually, this is going to hurt U.S. citizens and will have a “negative impact” on global economic development.

Meanwhile, after an overnight session during which some traders reported seeing policy banks selling dollars “aggressively” in the onshore market, China reinstated the reserve requirement on FX forwards. This is a big deal.

The PBoC will (again) require a reserve ratio of 20% for financial institutions engaged in forwards trading, in a move authorities say is designed to head off macro financial risks in light of recent FX volatility stemming from the trade frictions. The new rule goes into effect on August 6.

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It’s important to remember the context here. They’re dusting off a tool they deployed in 2015 and suspended last September. Let’s take a trip down memory lane for a minute.

Here’s one of my all-time favorite characterizations of the 2015 devaluation from BNP’s Mole Hau (I think he may be at ICBC now):

Whereas the daily fix was previously used to fix the spot rate, the PBoC now seemingly fixes the spot rate to determine the daily fix, (thus) the role of the market in determining the exchange rate has, if anything, been reduced in the short term.

Well last summer, when the yuan was sitting around 6.90, the PBoC introduced a laughably opaque “counter-cyclical adjustment factor” designed to engineer a short squeeze in the currency, perhaps in an effort to placate Trump. That amounted to a rolling back of whatever liberalization was ostensibly embedded in the “new” FX regime that went into effect in August 2015. Effectively, they went back to manipulating the fix to control the spot but they also retained the discretion to intervene in the spot market (and they subsequently did), which effectively meant that last summer, they were manipulating the fix and the spot and because the latter informs the former, the whole thing was fixed.

That led directly to a historic rally in the yuan versus the dollar that ran so far, so fast,Beijing ultimately had to put the brakes on the situation in early September by relaxing rules on forwards put in place following the 2015 devaluation. Those rules were reinstated on Friday morning. Here’s an annotated history of this:

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As a reminder, recent yuan depreciation (the second red oval in the chart above) has effectively served to zero out the impact of the first two rounds of 301 tariffs (i.e., the duties on $34 billion in Chinese goods that went into effect on July 6 + levies on $16 billion more forthcoming and prospective tariffs of 10% on an additional $200 billion in exports to the U.S.).

It looks like the prospect of the USTR upping the rate to 25% in the next round was set to bring about more currency weakness than the PBoC was willing to risk.

Remember, this was always a bet that capital flight wouldn’t accelerate – that was the only check on China’s willingness to countenance yuan weakness. Apparently, 6.90 was it when it comes to where they drew the line. So, they reinstated the forwards rule and simultaneously announced how they plan to respond in the event the Trump administration does indeed decide to raise the stakes by more than doubling the rate of proposed duties on $200 billion in additional Chinese goods.

In a subsequent statement, the PBoC reiterated that the reinstatement of the forwards rules does not amount to capital controls. “It doesn’t limit the amount of contracts companies can enter into and deal-by-deal approvals aren’t required for such transactions”, the central bank said, before characterizing this as “part of China’s macro prudent policy framework.” They also emphasized that it doesn’t alter corporations’ ability to employ forwards as a hedging tool.

The comment period on the next round of Trump tariffs is set for August 20-23 and in the meantime, Steve Mnuchin is supposed to be negotiating with Chinese Vice Premier Liu He to avert a potential disaster. Friday’s measures suggest China isn’t holding its breath on that.

And who can blame them? After all, it was just Thursday when Wilbur Ross told Fox News that Trump “feels that it is potentially time to put more pressure on in order to modify [China’s] behavior.”

Well, question for you Wilbur: How’s that working out for you on Friday?

Full statement from China’s Ministry Of Finance

August 3, 2018 Source: Office of the Customs Tariff Commission of the State Council

　　On July 11, 2018, the US government issued measures to impose a 10% tariff on imports of approximately US$200 billion from China. On August 2, the US Trade Representative stated that it intends to increase the tax rate from 10% to 25%. The United States has deviated from the consensus of the two sides on several occasions, unilaterally escalating trade frictions, seriously violating the rules of the World Trade Organization, undermining the global industrial chain and the free trade system, substantially harming the interests of our country and the people, and will also include the United States. The world economic development has had a negative impact.

　　In response to the above measures by the US, China was forced to take countermeasures.According to the “People’s Republic of China Foreign Trade Law”, “People’s Republic of China Import and Export Tariff Regulations” and other laws and regulations and the basic principles of international law, the State Council’s Customs Tariff Commission decided to purchase about 60 billion US dollars of goods under the US$5,207 tax items. Add tariffs of 25%, 20%, 10%, and 5%. If the US is willing to go its own way and implement its tariff increase measures, China will implement the above-mentioned tariff increase measures.

　　The Chinese side adopts the above-mentioned tariff-adding measures to defend its legitimate rights and interests, and to counter the escalation of trade friction through counter-measures. At the same time, relevant measures have also minimized the impact on China’s domestic production and people’s living needs. After the implementation of the above measures, the relevant departments will evaluate the effectiveness of the measures with the community and strive to minimize the impact of the measures on China’s domestic production and life.

　　China promises to continue to promote reform and opening up in accordance with the established deployment and rhythm, firmly support economic globalization, firmly uphold the principle of free trade and the multilateral trading system, and develop and share prosperity with all countries in the world pursuing progress.