Will China Start A Currency War Against The Dollar?

China’s currency approaching levels seen at the start of the year. Investors think a 7-to-1 exchange rate is in the cards as China’s economy starts protecting itself from a trade war. (AP Photo)

Will China start a currency war against the dollar?

The action would be in retaliation against Trump trade tariffs, with a weaker yuan better for Chinese exporters. The problem is that the yuan’s weakness has about as much to do with Fed tightening and reducing its balance sheet as it does the People’s Bank of China moving the needle on its managed free-float trading band.

Some global investors think the yuan is going to 7.25, especially if the dollar continues to strengthen.

“If the dollar keeps strengthening and gold goes below $1,200 an ounce, you should not be surprised to see the yuan go to seven plus. The correlation between them is that strong,” says Vladimir Signorelli, a macro-investment analyst at Bretton Woods Research in New Jersey.

China’s yuan trades within a band of four percent in either direction. If the currency moves higher on that band, the central bank will take the high point and make it the start of a new 4% price range. The currency is down 8% since April and 4% year-to-date.

“We see a moderate depreciation in the yuan in the near term,” says Richard Turnill, chief investment strategist at BlackRock in New York. “Chinese authorities are managing competing policy goals in a challenging environment,” he says.

The Fed is tightening and shrinking its balance sheet, which is reducing the number of dollars out there. That’s a positive for dollar bulls, but it is also making U.S. exports more expensive. For China, seen as a competitor for U.S. businesses in Asia and elsewhere, the yuan’s weakening to 6.80 on Monday morning is a combination of dollar strength and a slower Chinese economy.

The yuan has been at this level before. It tested 6.90 at the start of the year. The Chinese currency has been weakening since the election of Donald Trump.

China is in semi-panic mode. They’re cutting taxes, cutting interest rates and initiating fiscal policy changes to stimulate the economy, all in anticipation of tariffs.

Turnill said he does not see China resorting to a 2015-style devaluation to cushion the blow from trade tariffs. Though his calculation at this time is based on the $50 billion in tariffs enacted this month. Trump is threatening over $200 billion more in tariffs, which would absolutely bring the trade war to Defcon 4.

U.S. Treasury Secretary Steven Mnuchin gives a press conference at the G20 meeting of Finance Ministers and Central Bank governors in Buenos Aires, Argentina on Sunday, July 22, 2018. G-20 finance ministers and central bank chiefs are meeting in Buenos Aires amid fears over U.S. President Donald Trump’s trade policies and the potential impact of a currency war. (AP Photo/Gustavo Garello)

See: China’s Dead Cat Bounce? — Forbes

Here’s How China Protects Itself From A Trade War — Forbes

Sorry, Bill Maher. U.S. GDP To Grow China-Like At 5% — Forbes

In 2015, a lack of market confidence in China’s currency policy contributed to capital flight, spooking global markets. China later said that it was changing its trading band for the yuan in anticipation of joining the International Monetary Fund’s currency basket, the Special Drawing Rights.

China has stricter capital controls in place to avoid panic selling of the yuan—and improved coordination between policymakers. For Turnill, this should give the government the confidence to allow the yuan to gradually slide lower.

“A sharp yuan depreciation would undermine Beijing’s deleveraging effort, by driving capital flight and further tightening domestic financial conditions,” Turnill says. “It could also fuel inflation and dampen foreign investors’ growing interest in China’s domestic stock and bond markets.”

The A-shares of mainland China companies are down over 20% from their highs reached on January 26. The XTrackers Harvest CSI-300 China A-Shares (ASHR) exchange-traded fund is down a tad on Monday and off 17.5% year-to-date.

The U.S. Treasury does not consider China to be a currency manipulator. Therefore, any weakness in the yuan is more likely a market move than the handiwork of Beijing central bankers.

President Trump said last week the Fed’s hawkishness is making the dollar uncompetitive. Unsurprisingly, Fed officials are pushing back against any interference in their independence and said monetary policy is not a mystery.

The Fed meets again next week and markets expect another 25 basis points rate hike, the third this year. That will likely push emerging-market currencies lower, including China’s.

The market expects one more rate hike this year, three more next year and one more in 2020.

At that, Trump noted that the Chinese currency has “dropped like a rock,” implying that China is manipulating the currency. Treasury Secretary Steve Mnuchin says the U.S. will investigate whether the recent yuan depreciation is the result of manipulation and the findings will be presented in the usual semiannual Treasury report in October.

Meanwhile, Trump is threatening to impose tariffs on all Chinese imports, making the yuan even more bearish than the Fed’s monetary policy.

“The trade war continues to escalate,” says Neil MacKinnon, an economist at VTB Capital. “Right alongside what looks like an outright currency war,” he says.

Comments are closed.