Trade war escalation threatens USDCNY cap

Forex 5 minutes to read

John Hardy

Head of FX Strategy

Summary:  Global markets are remarkably complacent as this weekend saw a significant escalation of the US-China trade showdown, which increasingly deserves the moniker “trade war”. The stakes will rise dramatically if USDCNY trades is allowed to move above 7.00.


Markets are jaw-droppingly stable, given significant escalation at the weekend of measures against China’s Huawei, in addition to signs that China’s leadership is digging in for a longer confrontation with the US rather than giving in to the latter’s pressure. Consider the FT column “Xi Jinping is preparing China for a long trade war”  that outlines the case, describing an increasingly belligerent tone in media. (A scan of headlines and some of the commentary at China’s official news service,  Xinhua, offers some flavour.) 

But easily the biggest story over the weekend was Google’s move to cut off access to Huawei devices for updates to Android and Google services. This comes on top of the implications for chip-makers who must now suspend supply of chips to Huawei after the US administration placed the Chinese company on its “Entity List”.

Still, markets are remarkably stable, with the US equity futures somehow higher overnight, even if EM equities have lurched into an ugly slide over the last couple of weeks, somewhat at odds with the underlying currencies, which as a group have only suffered a sedate slide over that time frame. But let’s not be fooled – that latter relative calm is likely buttressed by the assumption that China will continue to cap USDCNY at 7.00 – if that policy is abandoned, significant volatility is likely to propagate across currency and all asset markets. Arguably, China will need to loosen monetary policy aggressively to counter the risks to growth from the trade showdown and this can only add to the pressure on the currency to weaken.

A big shock in Australia at the weekend as the election saw the incumbent Liberal National coalition defying all of the polls and eking out a victory. The Aussie celebrated with a gap higher to open the  week, as the Labour opposition’s more stern climate change policies were seen as a likely headwind for economic growth. Given the backdrop of the US-China showdown and the inertia of the clear shift in the Reserve Bank of Australia’s guidance, however, the AUD rally could prove very short-lived, though a cross like AUDNZD may have now found a low here.

Trading  interest

Looking to fade AUDJPY bounce as long as we remain below 77.50.
USD longs via AUDUSD short (stop above 0.7000) and EURUSD short (the latter in short-dated options near-the-money – implied volatility so low…) 

Chart: EURUSD

EURUSD is marching back toward the cycle lows, driven entirely by broad USD strength. Europe  faces an interesting political test over the next six months on the upcoming European Parliament elections this week and the leadership change at all levels by November 1 (European Central Bank included). Europe has plenty to lose from a US-China trade war on the impact to its highly export-leveraged economy. With German Bunds (10-year sovereign debt) marching to a new low for the cycle at negative 10 basis points, only 10 bps from the record low back in 2016. Little to attract investment flows into Europe in this environment! Let’s see if a new low can finally catalyze a more notable trend – it may only be possible to achieve anything significant to the downside in EURUSD beyond 1.1000 if the USDCNY has been loosened to the  upside of its current trading range below 7.00.
Source: Saxo Bank
The G10 rundown, express edition

USD – the US dollar is firm, but for something more significant to unfold, we may need to see USDCNY shaking loose of the assumed cap.

EUR – little to like here and interesting to see whether the parliamentary elections jolt peripheral (read: it’s all about Italy for now) spreads wider.

JPY – back up in JPY crosses makes little sense here – strong Japanese Q1 growth report overnight an interesting counterpoint to the news flow.

GBP – is there really any suspense ahead of the vote on May’s doomed deal? Sterling generally at risk of probing lower levels on the uncertainty.

CHF – some safe haven seeking in recent evidence in line with risk periodic risk appetite wobbles. A referendum at the weekend saw Swiss voters favouring more alignment with EU rules – but a bigger set of “framework” reforms is a huge test for the country’s markets.

AUD – a boost to the negative sentiment on the election outcome, but this may not last long, given the risks to the Australian economy from the US-China trade showdown, with the current government coalition seen as far less China friendly than the Labour opposition. Watch out for RBA Governor Lowe out speaking in Australia tonight.

CAD – the loonie getting a boost from the US dropping steel and aluminum tariffs on Canada and Mexico, but USDCAD unlikely to escape the general direction in the USD. Volatility impossibly compressed.

SEK – some further room for EURSEK consolidation into 10.60-65- the downside pivot zone. SEK will likely do poorly in an escalation of trade war risks.

NOK – the krone getting little boost from oil trading near the highs – perhaps on the massive backwardation of the price curve. The currency at significant downside risk if oil breaks lower.

Upcoming Economic Calendar Highlights (all times GMT)

0800 – Eurozone Mar. Current Account
1230 – US Apr. Chicago Fed National Activity Index
1700 – US Fed’s Clarida and Williams (both FOMC Voters) at “Fed Listens” event
2300 – US Fed Chair Powell to speak
0130 – Australia  RBA Meeting Minutes
0310 – Australia RBA Governor Lowe to speak
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