On Thursday, Donald Trump fired yet another shot across the bow in the burgeoning global trade war, but not with a tariff threat, rather with a stunning rebuke of Jerome Powell’s Fed.
In a truly remarkable interview with CNBC’s Joe Kernen, Trump expressed his dismay at ongoing rate hikes which he clearly believes have the potential to put the brakes on his MAGA miracle economy.
While it’s unlikely that Trump understands (or cares) about the nuance, he probably does have a decent grasp on the rather precarious dynamics at play in the U.S. debt market, where Treasury supply is rising (to fund the tax cuts) and the Fed is running down the balance sheet. That’s likely to put upward pressure on the term premium at some point and when you throw in the hawkish Fed, you’re left to ponder what Jeff Gundlach has variously described as a “suicide mission” and a “death wish.” Here’s what Jeff said in an interview with Barron’s out late last week:
It’s like a death wish. The U.S. is taking on hundreds of billions of dollars of debt while raising rates, which means our debt-service payments are going to be under serious pressure to the upside.
So in addition to Fed hikes imperiling the stock market, they also threaten to lay bare the folly in Trump’s fiscal policy.
As if that’s not enough, Powell’s hikes mark a rather stark juxtaposition with China’s ongoing efforts to loosen policy. The policy divergence between the Fed and the PBoC is part and parcel of what’s pushing the yuan inexorably weaker. There’s a ton of analysis on this in “‘It’s Got A Green Light To Weaken’: Yuan Dive Continues As PBoC Looks On“, but suffice to say this is what’s going on (annotated to give you some reference points and context):
Trump explicitly cited the yuan in his CNBC interview on Thursday. “China’s currency is dropping like a rock,” he told Kernen, adding that “Our currency is going up, and I have to tell you it puts us at a disadvantage.”
Or, put differently, it softens the blow on China from the trade conflict and again, Powell is partly to “blame” for this (and the scare quotes are there for a reason) because the more hawkish Fed policy is relative to PBoC policy, the more weakness you can expect in the yuan.
Well on Friday, the PBoC weakened the fixing by the most since June 2016, in a clear sign that the PBoC is more than fine with letting the market push the currency lower. Remember, because it’s managed, doing “nothing” (if you’re the PBoC) is akin to doing “something” and given Trump’s efforts to talk the dollar lower on Thursday, you’ve got to think Yi Gang was attempting to hit back a bit on Friday. Have a look at this:
Although CNH would subsequently trim its losses (and as usual, there’s no telling what will transpire overnight), the move shown above is worth noting in light of the fixing (noted above) and in the context of Trump’s broadside on the Fed.
Meanwhile, BofAML might have closed out their USDCNH long a bit too early:
should have stuck with it guys…. pic.twitter.com/eyoDmXZP0J
— Walter White (@heisenbergrpt) July 20, 2018
The rationale was as follows:
- The PBOC’s preference is for some easing in monetary and financial conditions by trade-weighted CNY depreciation
- The possibility for capital outflows by MNCs
- Credit concerns on corporate external debt, especially in property sector driven by loan/bond repayments.
Long story short (no pun intended), BofAML thinks all of that is still in play, but as ever, this is a guessing game. No one knows just how comfortable the PBoC is with the robustness of the measures put in place following the 2015 devaluation to guard against capital flight. They clearly believe they are in a better position now than then, but at a certain point, they’ll put the brakes on this. Last month, BNP suggested 6.85-6.90 is the likely intervention zone (hence the yellow highlight in the annotated chart above). Here’s BofAML:
We continue to believe that these drivers are intact, but we are reluctant to chase the move for further CNY depreciation. This is because we believe we are reaching an inflection point where either China’s policy makers come in to intervene more aggressively and potentially squeeze CNH liquidity, or risk facing sustained capital outflows and accelerated CNY depreciation. This latter scenario would be counterproductive in our view as sustained outflows would squeeze overall liquidity and result in a de facto monetary tightening. Indeed, this would jeopardize the PBoC’s backdoor FX monetary easing with the CFETS basket approaching a more comfortable level of 94.0. This represents a 3.8% trade-depreciation in one-month, but so far without the bad side effects of capital outflows and liquidity tightening.
As ever, it’s a tightrope walk.