Well, Donald Trump has officially kicked off a currency war, it would seem.
If you doubt that assessment, just ask the PBoC, which weakened the yuan fix by the most since 2016 on Friday just hours after Trump said the currency was “dropping like a rock” while suggesting the Fed shouldn’t be hiking rates because it increases the policy divergence between the U.S. and its trade partners, thereby helping America’s “competitors” (as Trump calls them) weather the tariff storm.
On Friday, following Trump’s tweets and his contention that the administration is all set to “go to $500 billion” when it comes to tariffs on China, the dollar had its worst day since March.
In an interview with Fox News, OMB Director Mick Mulvaney attempted to “explain” Trump’s position as follows:
[He’s] frustrated that every time things seem to start getting a lot better, the Fed pumps the brakes. We just wish the Fed would give some thought to the supply side of the economy every now and then.
That is absurd and also beyond the pale.
“Trump’s recent comments about a strong USD putting the US at a disadvantage and accusing China and the European Union of currency manipulation suggest it will be more difficult for the USD to extend gains as trade tensions escalate, unless US officials at the G20 meeting this weekend attempt to dial back his comments and reiterate the United States’ strong USD policy”, BNP warned, in a note dated Friday.
“We’ve been expecting for a while to start to hear U.S. administration complaints in some form or another about dollar strength,” the bank’s Daniel Katzive said in an interview with Bloomberg TV, adding that while “these comments are not a surprise, they are going to be a factor that limits how much the dollar can benefit from the trade war story.”
Scotiabank’s chief FX strategist Shaun Osborne called Trump’s tweets “excessive” and indicative of the President’s “willingness to run over conventional policies.” He went on to caution that this is “dangerous territory for the USD”.
Credit Suisse’s Shahab Jalinoos echoed those sentiments, calling Trump’s tweets “very direct and aggressive”.
For his part, former Goldman Chief FX strategist and current Chief Economist at the IIF, Robin Brooks, had the following to offer about the decision calculus for the PBoC now that we seem to be bumping up against key thresholds in the yuan beyond which capital flight could become an issue:
The trade-weighted RMB has now unwound the sharp rise from early 2018. So I still see much of the recent devaluation as a correction of excess strength. But 2 caveats: (i) speed of the move, which is unprecedented; and (ii) context of trade tensions with the US.
The Dollar has been pretty stable since late May (black), so recent RMB devaluation (blue) isn’t a response to Dollar strength. Instead, it in my view is a signal that China initially used the RMB to “play nice” in the trade dispute, a strategy that is now over.
China has lots of constraints if it wants to use RMB devaluation as offensive tool. Risk assets would fall globally, tightening financial conditions in China (counterproductive). Domestic capital flight (blue) could resume also. $/CNY near 7.0 is critical level.
Trump is playing with fire here. 2015 is still fresh in the minds of traders and if China decides that they’re willing to risk capital flight in the interest of protecting the economy, the ensuing weakness in the currency could quickly spillover into regional assets on the way to catalyzing a bout of global risk-off sentiment.
Additionally (and I keep saying this), Beijing could well let the yuan drop precipitously and then cite “irrational” market behavior as an excuse for a move to start selling U.S. Treasurys in order to put the brakes on the slide. That would kill two birds with one stone. They’d get the devaluation they want in order to help shield the economy from the trade frictions and they’d have an excuse to weaponize their Treasury holdings.
I am not sure what makes everyone think that Beijing wouldn’t be willing to risk further weakness in the currency. They have demonstrated that they can and will resort to draconian measures to halt capital flight, and the idea that they would be concerned about the optics around that in an environment where Donald Trump is running roughshod over decorum and threatening to upend every international norm in his pursuit of a “victory” in the global trade spat, seems far-fetched.