“We have plenty of room in interest rates, we have plenty of room in required reserve ratio rate, and also for the fiscal, monetary policy toolkit, I think the room for adjustment is tremendous”, PBoC governor Yi Gang said Friday, in an exclusive interview with Bloomberg.
In addition to that rather unambiguous assessment of China’s capacity to counter the tariff drag with monetary policy easing, Yi said there is no “red line” for the yuan, effectively throwing cold water on the idea that Beijing would mount an aggressive defense of 7 amid escalating trade tensions.
Well, if you ask Goldman, 7 is coming sooner rather than later.
“We see further scope for Dollar appreciation against the Renminbi, and we are moving our forecasts for USD/CNY to 7.05, 6.95 and 6.80 in 3, 6 and 12 months from 6.95, 6.65 and 6.65 previously”, the bank wrote Saturday.
As ever, this is a difficult call. China is engaged in a perpetual balancing act between letting the currency depreciate to cushion the blow from the tariffs and avoiding a scenario where “too much” depreciation triggers capital flight.
“Internationally [a breach of the psychologically important 7.00 level] may be perceived as an escalation that makes any eventual trade truce even harder to achieve”, Goldman remarks, in the same note. That said, the bank says capital flight worries and the perception that the yuan has been weaponized “should not be overemphasized” because “effective capital controls [should] keep any depreciation limited and gradual.”
We’ve variously argued that defending 7 might be counterproductive to the extent it reinforces market paranoia about a meaningless “line in the sand”. Better to let 7 fall and then intervene if things get out of hand.
Still, a breach of 7 would likely engender a sharp rebuke from Donald Trump, who would doubtlessly be alerted by advisors.
China has previously warned shorts of “huge losses” on speculative bets against the currency.
The irony is always the same: The US wants market forces to play a greater role in determining the yuan’s exchange rate, unless of course those market forces dictate a much weaker currency in the face of the tariffs, in which case the Trump administration expects China to intervene to keep it stable.
The trade war’s expected impact on the Chinese economy is in part responsible for a weaker exchange rate. The more intractable the Sino-US dispute appears, the looser the market expects China’s monetary policy to be. On Thursday, Barclays’ Jian Chang slashed her outlook for GDP growth in China to 6% in 2019 and 5.5% in 2020. “Our new baseline officially moves to the Escalation scenario in which the Trump administration applies 25% tariffs on nearly all Chinese exports to the US”, she wrote. Chang went on to warn about the impact on the global economy. “In addition to the direct tariff impact, our lower forecasts also reflect an increasing risk of global recession resulting from escalating trade protectionism, with the worldwide fall in manufacturing PMIs and sustained weakness in regional exports continuing to indicate retreating external demand”, she added.
When you throw a wrench in the engine of global growth and trade, you risk everything grinding to a halt. That, apparently, is a risk the Trump administration is willing to take.