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JPMorgan’s Normand Joins Analysts Expecting ‘All Out’ US-China Trade War, Expects Yuan Depreciation

One way or another...

Earlier this month, while speaking at the World Economic Forum in Tianjin, Chinese  Premier Li Keqiang promised China would not devalue the yuan to fight the trade war with Trump.

“Recent fluctuations in the renminbi exchange rate have been seen as an intentional measure, but that isn’t true,” Li said.

With all due to respect to Li, the PBoC clearly countenanced yuan depreciation from late June through early August. The central bank allowed the policy divergence between the U.S. and China to drift wider as upbeat U.S. econ data pigeonholed Jerome Powell into hawkishness. As the policy divergence grew and evidence of a deceleration in the Chinese economy accumulated, the currency rapidly weakened. The depreciation from late June through early August completely offset the effects of the first round of 301 investigation-related tariffs (duties on $50 billion in goods implemented in two steps on July 6 and August 23) and what was, at the time, still a theoretical second round of IP theft-related tariffs on $200 billion in Chinese exports to the U.S. (those tariffs are now a reality).

In August, when dollar-yuan looked liked it might push through a 7-handle, the PBoC moved in to slam on the brakes. Specifically, they reinstated forwards rules (August 3), chided onshore banks for selling RMB (August 7), moved to squeeze offshore liquidity (August 16), and reinstated the counter-cyclical adjustment factor (August 24). Here’s the annotated chart dating back to the the 2015 devaluation:

Yuan

(Bloomberg w/ annotations)

The point is, when you have a managed currency, doing nothing in the face of depreciation pressure is the same as doing something, and China clearly took advantage of the growing policy divergence between the Fed and the PBoC to allow the yuan to weaken. Last month, Beijing appeared to have reached what China believes is the point of diminishing returns, so they stepped in to arrest the slide.

It’s now readily apparent that the Trump administration is prepared to take this fight all the way, eventually taxing everything China ships to the U.S. Goldman, for instance, puts the odds of Trump slapping duties on another $267 billion in Chinese goods by 2019 at 60%. Due to the disparity illustrated in the following chart, China will be forced to get “creative” when it comes to retaliating, and it’s hard to imagine that the yuan won’t be deployed at some point should things continue to get worse.

(Bloomberg)

Again, it’s difficult to pin down exactly what counts as “weaponization” when it comes to yuan weakness. The monetary policy divergence between the U.S. and China will likely continue to grow and that would put “natural” depreciation pressure on the bilateral rate. Because the threat of an all-out trade war with the U.S. imperils the Chinese economy, the Trump administration’s own actions are also contributing to souring sentiment around the yuan. Further, you can’t realistically expect the PBoC to sit idly by when it comes to keeping monetary policy loose in the face of a decelerating economy; but any easing measures from the central bank will only serve to further widen the policy divergence with the Fed.

So what counts as “active” measures to depreciate the currency and what is simply an example of the currency responding as you’d expect given the prevailing market dynamics? Who knows. It’s impossible to say “this is weaponization” but “this is not”.

Anyway, it’s worth noting that JPMorgan’s John Normand is now in the camp that thinks Trump will ultimately go all in. “JPMorgan has adopted a new baseline that assumes a U.S.-China endgame involving 25 percent U.S. tariffs on all Chinese goods in 2019,” he writes, in a new note.

Part and parcel of that call is a weaker yuan and Normand’s rationale echoes the common sense assessment presented above re: the likelihood that the monetary policy divergence between the Fed and the PBoC continues to grow.

“Looser Chinese monetary policy ensures that the U.S. dollar will become an ever-higher yielder versus the renminbi for the rest of the cycle,” he says.

JPMorgan’s yuan targets: 7.01 by year-end and 7.19 by September of next year.

Separately, Barclays noted last weekend that for the time being, authorities are actively keeping the currency at bay. “Recent large liquidity injections at open market operations suggest that the PBoC might have been intervening actively to cap USDCNY below 6.9, and our estimates suggest USDCNY fixings are being suppressed through larger counter-cyclical adjustment factor coefficients”, the bank said.

CCAF

(Barclays)

They followed up on that Sunday as follows:

We think the Chinese authorities will keep USDCNY below the psychological 7 level, resulting in mild depreciation, which would nonetheless keep pressure on the rest of the regional currencies. This week, as the CNY (CFETS) NEER tests a record low that prompted PBoC intervention, USDCNH will likely face resistance around 6.90, but a breakout above that level could spur fresh weakness in CNH as well as Asia in general (all of this week is a public holiday in China).

BarcCNY

You can draw your own conclusions here, but it seems just as likely as not that further yuan depreciation is in the cards one way or another.

We’ll leave you with a couple of brief thoughts from BofAML and Goldman.

BofAML (September 27)

  • The brinkmanship between China and the US continues, with China canceling mid-level negotiations this week, while President Trump continues to raise accusations against China. We are hopeful a trade deal can be done before the US midterm elections, but have laid out the scenario that the US proposal for 25% tariffs to be invoked on January would ultimately push USD/CNY to 7.10 by end-2019. As markets currently stand it appears that China’s officials are seeking to stabilize RMB with the CFETS basket holding above 92.00 and the PBoC announcing that it will issue CNH bills in an effort to control CNH liquidity and stabilize USD/CNH. On Swaps and bonds, we continue to favor a flatter curve and believe that the widening of credit spreads points to underlying deterioration in asset quality. This will favor perceived “safe-haven” buying of government bonds.

Goldman (September 21)

  • CNY: Devaluation will “do more harm than good”. In the future [tit-for-tat tariffs] are more likely than not to trigger more US tariffs. Going forward, China cannot extend tariffs on US goods much further, but it has other options to retaliate, including CNY devaluation. However, US ‘trade wars’ have tended to turn into ‘currency wars’ in which currency devaluation against the dollar is seen as provocative. Premier Li’s comments that “One-way devaluation will do more harm than good to China’s economy. China will by no means stimulate exports by devaluing the yuan” suggest that, though policy makers are likely to continue a broad-based policy loosening to offset the effects of trade tensions, a sharp weakening of the CNY is less likely—for now—to be part of this mix.
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