From Trade War to Currency War, CNY on the move

From Trade War to Currency War, CNY on the move

Macro 5 minutes to read

Summary:  The trade war is weighing on sentiment whilst cold war 2.0 bubbles in the background as geopolitical constructs that have upheld the global order as it has stood since World War II unravel, but traders are acutely focused on the level of CNY and the daily fix as a barometer of risk.


The 7.00 “line in the sand” for USDCNY has been breached for the first time since 2008, and last week saw the first Yuan fix weaker than 7.00 since 2008. This week the daily fix will continue to focus attention and direct risk sentiment, following Friday’s affirmation of continued mounting trade tensions from President Trump who said he was not ready to strike a trade deal with China and indicated the next round of talks scheduled for September might not take place.

The risks relating to the trade war continue to rise, particularly as the cyclical slowdown in global growth, which predates the trade war, takes its grip. The escalating trade tensions have become akin to pouring kerosene on what is fast becoming a synchronised global slowdown. The uncertainty paralyses decision making for multinational companies, burdens capex intentions and forces supply chains to be unravelled in order to remove risk. Globalisation has created global networks and supply chains that are under assault as tensions ratchet higher and the resetting of the US/China relationship can no longer be dismissed as the “art of the deal”. The China hawks within the US administration are in descent, wielding national security concerns, and Trump seems determined to reset the relationship with China, rather than allowing them to buy their way out with large soybean purchases. China’s mercantilist regime has become a bipartisan issue in the US and the onus is on Trump not to squander this opportunity to level the playing field. With every week that passes our longstanding notion that trade tensions are a sideshow for a long-running economic conflict and battle for tech dominance and hegemony, and that tensions were set to accelerate, becomes ever apparent. Tariffs and the bilateral trade deficit are just scratching the surface in a far deeper rift. As we have said many times, the tariff impact on global growth will be pervasive, non-linear and lagging, yet equities have basked in a warm glow of complacency. Placing infallible confidence in the hope of a trade deal and the ability for central banks to underpin earnings and pivot the economic cycle. What could go wrong?

The latest tariff announcement has further intensified the tensions and it looks like the two sides are now rousing the troops in a protracted bind as previously drawn out battle lines are reinforced. Hu Xijin, the editor of the Global times, a state-controlled newspaper in China that is widely thought of as a “mouthpiece” for Beijing outside of the party’s official statements, has tweeted: “Washington's repeated bullying has made it meaningless to continue trade talks in short run. China is mobilizing internally to fight firmly with the US, and all official media is participating in the mobilization. China and the US are caught in a stalemate worse than last round”

The US treasury labelling China a currency manipulator last week was clearly in retaliation to the Yuan breaching 7.0 and marks a rapid deterioration in relations. It will now be significantly harder for either side to backpedal from the current position and even a superficial deal looks a long way off, if at all. This war of attrition is no longer being fought through trade and tariffs alone, we have moved to technology and now currencies. Marking the end of the beginning in trade war turned economic war, where no tool is off the table.

In terms of manipulation the irony is that Beijing have actually taken steps to prop up the value of the currency, limiting depreciation and have consistently fixed CNY stronger than the market forces would imply. The currency remains under fundamental pressure, depreciating as growth slows, monetary policy is eased, tariff measures impact and the trade war bites. And if CNY were floated the currency would be significantly higher today without PBOC intervention due to market pressures. Although we should see a weaker CNY due to market forces, none the less the direct linkage between the USD/CNY breaching 7.00 for the first time since 2008 and rekindled tensions has weaponized the currency and shots have been fired signalling China can and will use the currency to mitigate the impact of tariffs on exporters.

The Yuan will continue to be a proxy of China’s intent and the state of trade negotiations. Every day the USD/CNY reference rate (fix) is weaker and the CNY continues to depreciate. Previous strength was evident of negotiations continuing in good faith. But given Trump’s latest announcement of further tariffs just as the 2 sides resumed talks is the polar opposite of one of China’s key demands, negotiating in good faith, we have seen warning shots fired. And if the additional tariffs go ahead on September 1st CNY will depreciate further. Back of the envelope calculations suggest a $30bn impact to be offset (10% tariff on $300bn imports = $30bn), if we assume the current level accounts for pre-existing tariffs, USDCNY will be headed upwards of 7.30. And that is without accounting for potential non-linear impacts of accumulated tariffs and the hit to growth.

In the event these tariffs were raised to 25% in a more severe escalation of tensions we could see a more marked depreciation, pushing up past 7.50, but this is not the base case.

The slow and steady depreciation is managing sentiment and therefore capital outflows. But even though the impact on sentiment has been relatively light, given the fixing has been consistently stronger than estimates and previous close, make no mistake the trend is weaker, and the yuan is slowly but steadily depreciating. Administrative measures preventing large capital outflows remain intact and the managed devaluation is preventing a panic rush for the exits from ensuing allowing the PBOC to devalue CNY without uncontrolled outflows. This is a top priority for the PBOC for whom the scars of 2015/2016 panic run deep, which will prevent any intent and rapid depreciation from occurring.

Even prior to this latest trade escalation the PBOC were managing the message, preparing the market for any such measured move, hinting there was no line in the sand at CNY 7.00 per dollar. Again, signalling that the PBOC would like more flexibility in the exchange rate, but stability will always be a key focus so as not to dent credibility. Which would deter the long-term goal of internationalising the Yuan. Another hindrance to a significant CNY depreciation is the high levels of USD denominated debt held by Chinese corporates, Chinese property developers and other corporates who have international debt priced in dollars will struggle to foot the bill upon any significant devaluation as most of their earnings are CNY.

Never the less it is likely we see a continued CNY weakness, proceeding in the same measured manner, as the PBOC persist in engendering further exchange rate flexibility thus desensitizing the market away from the 7.00 level. Depreciation is likely to be capped at 7.50 throughout 2019, unless we see another marked escalation in the US/China relationship for example 25% tariffs on all Chinese imports. Continued CNY depreciation could also lead to downside in other EM Asia currencies setting off a competitive devaluation. The continued depreciation is unlikely to sit well with President Trump and the weaker CNY tracks the more likely 10% tariffs on so far untargeted imports go ahead on September 1st.

Meanwhile the combination of falling producer prices as China PPI contracts for first time since 2016, along with the CNY depreciation, is indicative of mounting global deflationary pressures. Add in the continued slide in oil prices, iron ore prices collapsing as the supply shock rally recalibrates given global demand is faltering and a copper chart that looks ready to break and it is clear disinflationary forces loom large. In this this environment as a synchronised global slowdown takes effect there is no reason that bond yields should be heading higher and there is a good chance Fed must cut by more than the market is currently implying. Race to the bottom anyone?

Quarterly Outlook

01 /

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.