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U.S. President Donald Trump steps off Air Force One after arriving at Andrews Air Force Base, Maryland on Sept. 26, 2019.Evan Vucci/The Associated Press

The Trump administration is considering measures that would limit the flow of U.S. investment into Chinese companies, including banning Chinese companies from listing on U.S. stock exchanges, marking an escalation of the trade war between the world’s biggest economies.

Stock markets, already digesting a rash of disappointing global economic news and the impeachment inquiry into President Donald Trump, were rattled on the news of yet another disturbance.

After starting the day in positive territory, the S&P 500 fell as much as 32 points in late afternoon trading on Friday. It closed at 2961.79, down 15.8 points or 0.5 per cent, capping its worst weekly performance in five weeks. Canada’s S&P/TSX Composite Index fell 0.6 per cent in a broad sell-off.

U.S.-listed Chinese firms were hit particularly hard on the news. E-commerce giant Alibaba Group Holding Ltd., which trades on the New York Stock Exchange, dropped 5.2 per cent. Search company Baidu Inc., which trades on Nasdaq, fell 3.7 per cent.

“It’s certainly not good news,” said Douglas Porter, chief economist at BMO Nesbitt Burns. “It punishes Chinese companies. But by the same token, it can weaken the yuan, which is exactly the opposite of what the United States is trying to achieve.”

The removal of Chinese companies from U.S. stock exchanges would be a big deal, given it reduces their access to overseas investors. There were 156 Chinese companies with a combined value of US$1.2-trillion listed on U.S. exchanges earlier this year, according to the Financial Times, drawing on a report by the U.S.-China Economic and Security Review Commission.

But the administration of Mr. Trump may also put limits on financial investments between the two countries and restrict American pension funds from investing in Chinese stocks, according to multiple news reports that cited unnamed sources close to the deliberations.

The reports noted that the discussions have yet to work out the details on how such limits would be imposed, raising questions about whether the escalation is a negotiating tactic ahead of trade talks.

“It indicates a very harsh stance by the United States heading into the restart of trade talks. If it is a ploy, it’s a strong opening gambit and a pretty tough stand to take with China. It certainly isn’t a friendly move by any means,” Mr. Porter said.

The news of potential financial restrictions on the flow of capital adds to the uncertainty that has been weighing on the stock market for more than a year, with trade tensions blamed for slowing global economic activity. It also raises questions about the recent constructive tone on trade discussions between China and the United States. China announced this month that it would lift tariffs on U.S. soybeans and pork.

Canada has been caught in the middle of the dispute between China and the United States, given the significant trading relationship it shares with the two belligerents.

Economically sensitive and export-driven sectors of the Canadian market were among the hardest hit on Friday, reflecting concerns with trade. Technology stocks fell 1.5 per cent, materials dropped 1.7 per cent and industrials dipped 0.9 per cent.

But the impact of the move by the White House could have a far more widespread impact on investors, since any move to restrict money from China’s capital markets would likely hit funds – including popular exchange-traded funds, or ETFs – that hold Chinese stocks.

Many comments from observers also pointed out that China holds significant sway if it decided to retaliate against the U.S. move, given China’s vast overseas assets and investments in U.S. government bonds, raising the risk that the trade war will continue far longer than many had expected.

“This policy risks reciprocity from China, where China is of course a much bigger player in U.S. portfolio markets, than the U.S. is in China," Alan Ruskin, chief international strategist at Deutsche Bank AG, told Bloomberg.

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