SHANGHAI/HONG KONG (Reuters) – Chinese shares ended higher and the yuan strengthened on Friday as investors bet Beijing and Washington would be able to salvage a trade deal, despite a hike in U.S. tariffs that sharply escalated their dispute.

Even though the U.S. tariff increase on Chinese goods went into effect at midday as planned, investors took heart that both sides were returning to the negotiating table later on Friday for a second day of talks.

Traders also expect Beijing may announce more policy easing and support measures if the latest U.S. move heightens pressure on China’s economy.

“The fact that the two sides have agreed to continue negotiations on Friday is offering a glimmer of hope that the relationship between the two powers hasn’t deteriorated beyond repair,” said Jasper Lawler, head of research at London Capital Group.

China’s major stock indexes ended more than 3% higher on Friday, rebounding sharply in afternoon trade after briefly dipping into the red when the higher U.S. tariffs took effect.

While the quick turnaround sparked questions of state support, Khiem Do, head of Greater China investments, global markets at Barings, said whether the markets were “boosted by non-commercial buying support is unknown.”

Despite Friday’s surge, the Shanghai Composite Index and the blue-chip index still shed 4.7% and 4.5% on the week, pushing them to near 3-month lows.

Global markets were stunned by U.S. President Donald Trump’s announcement on Sunday that he would raise existing tariffs on $200 billion worth of Chinese goods in the midst of trade negotiations. Beijing has said it will retaliate but has not yet given details.

Investors had largely been betting on a U.S.-China trade deal soon, and the escalation comes as China’s economy has started to show signs of stabilization, thanks to a flurry of growth-boosting measures.

“The market has had a couple of days to look at this scenario, and has partially factored in increase in tariffs from 10 to 25 percent,” said Dennis Lam, equity analyst at UBS Global Wealth Management’s chief investment office in Hong Kong.

“More importantly, these negotiations are still ongoing. There is no concrete evidence that things will get a lot worse,” he said, adding that the market will focus on whether positive news emerges over the weekend from the Washington talks.

Some market watchers also saw a potential silver lining in the growing row, noting it could encourage more policy support. Signs of progress in trade talks and expectations of more stimulus had helped push China’s benchmark indexes up more than 30 percent earlier this year.

“Chinese and other policymakers around Asia are likely to be more, rather than less, accommodative. Already we think that China had held back on some stimulus in case negotiations failed,” said Howard Wang, Head of Greater China Equities, J.P. Morgan Asset Management.

The smaller Shenzhen index ended up 3.8% and the start-up board ChiNext Composite index finished 4.4% higher.

In Hong Kong, the Hang Seng index ended up 0.8% on the day, but lost 5.1% for the week, its biggest weekly loss since February 2018.

YUAN

China’s yuan finished the domestic trading session up 0.2% at 6.8118 per dollar, but was still down 1.13% for the week, on track for its worst week versus the greenback since July 2018.

On Thursday, the currency broke through key psychological support level of 6.8 for the first time since late January.

The yuan firmed on Friday despite China’s central bank setting the midpoint of its daily trading band at its weakest level in 3-1/2 months before the market open.

Friday’s soft fix came after the tariff-induced sell-off in the spot market on Thursday, although traders had expected it to come in even lower.

The offshore yuan had a volatile day, weakening slightly around midday, but was a hair stronger at 6.8394 per dollar on Friday afternoon.

“Trump is very fickle-minded. And investor sentiment had switched from overly optimistic to overly pessimistic,” said Zhou Hao, senior EM economist at Commerzbank in Singapore.

Zhou said that investors now felt that “as long as trade negotiations continue it’s a good thing.”

Zhou said he did not think the rebound would be sustainable, and expects the yuan to trade in a range of 6.75 to 6.9 per dollar.

The surprise deterioration in U.S.-China trade talks has prompted analysts to dramatically turn bearish on the Chinese yuan, a Reuters poll showed on Thursday, with short positions at their highest since mid-December.

Chinese government bond futures were unfazed by broader market volatility. Chinese 10-year treasury futures for June delivery, the most-traded contract, were last up 0.15 percent at 97.140.

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