The new week got off to a rather inauspicious start when the offshore yuan sank to a record low, pushing through the psychologically important 7-handle.
The move came after the PBoC set the yuan fix weaker than 6.90 for the first time in 2019. Subsequently, losses accelerated, pushing USDCNH through 7.10. Commenting, the PBoC said the move in the currency is “due to tariff expectations and protectionism”.
This, folks, is a big deal.
“USD/CNH screams to a record high and it will be hard to get this particular genie back in the bottle after the PBOC substantially weakened the fixing”, Bloomberg’s Mark Cranfield noted, adding that “traders will use [this] a reason to hit most EM currencies”.
This may be the first sign that Beijing is prepared to strike back at Trump by weaponizing the currency. Remember, contrary to the White House’s rhetoric which suggests China has been hard at work trying to devalue the yuan, the reality is that the currency would have breached 7 on a number of occasions if it weren’t for the PBoC’s efforts to keep things stable in the interest of keeping hopes for a trade deal alive.
“The calculus on preventing a break of 7.0 will change if policymakers believe the latest tariffs lock the two sides into a stalemate/escalation scenario”, SocGen’s Jason Daw warned last week, following Trump’s trade tweets. “If so, there is no incentive to stop the CNY from depreciating at least in line with its trading partners”.
“We have argued in the past that an escalation in tariffs such as the threatened 10% on USD300bn of Chinese imports could easily justify a rise above 7.00 as an offset to the tariffs and partial support to Chinese exporters”, BofA said Friday.
The knee-jerk reaction across assets was predictable. As the yuan dove, US equity futures plunged, extending losses from last week.
Meanwhile, Treasurys rallied, with 10-year yields falling below 1.80%. At the front-end, markets are now pricing in five Fed cuts (including the July move) by the first quarter of 2021.
On Friday, as markets reeled from the latest trade broadside, Goldman recommended investors open new longs in USD/KRW and USD/TWD and reiterated their forecast that USD/CNH would rise to 7.05. As noted, 7.05 on the offshore yuan fell on Monday. USDKRW surged 1% to 1,209. The Aussie and the kiwi were sold “aggressively” according to Asian traders.
If the PBoC doesn’t step in to put the brakes on this at some point later in the session, it can (and probably will) catalyze a global wave of risk-off sentiment.
This is precisely what we meant in our week ahead preview when we said the following:
Beijing continues to insist they will not be bullied or “blackmailed” by the Trump administration and traders will be watching for any signs that Xi is looking to move towards instituting more non-tariff retaliatory measures.
Consider a plunging yuan Exhibit A. China has two so-called “nuclear options” in the trade war with Trump, one is a rapid depreciation of the yuan and the other is the liquidation of US Treasurys. Don’t let it be lost on you that China could conceivably set in motion a quick move lower in the currency and then cite “irrational” market behavior as an excuse to step in and dump Treasurys to put the brakes on the depreciation, thereby killing two birds with one stone.
In any event, this is a decidedly bad omen and one hopes Trump’s aides and advisors (i.e., Steve Mnuchin) explain how pivotal a moment this really is. If this gets out of control, it could spell bad news – and on the fourth anniversary of the 2015 devaluation no less.
“If the yuan depreciates further, we could see a liquidation of assets by Chinese global investors if we see margin calls getting triggered”, IG Markets analyst Kyle Rodda told Bloomberg.
Of course, Trump is just as likely to fly off the handle as he is to carefully consider the implications of pushing the envelope further. “The US administration would interpret a move above USD/CNY 7.00 as an indirect retaliatory action”, BofA cautioned in the same Friday note mentioned above.
Stay tuned. As Trump would say, “the ratings will be tremendous”.
Cheaper imports and a strong dollar will keep the Americans at the Dollar stores from rioting and destroying the cities. The strong dollar must continue to appreciate for if prices were to rise that would spell the end. This is good news, let them depreciate their currencies. I love cheap stuff!!!
Soon with all the world’s bond markets under 0% the proverbial putting one’s currencies under the mattresses will again come back in vogue. Who the hell wants to pay money to save money????
Perfect time for the Federal Reserve to sell as many treasurys they have accumulated during this QE madness and keep selling until rates rise above 3.5% I would do that if I was in charge. I’d SELL IT ALL all 4 trillion if that is what it takes to get rates up in this mad mad world
Rare earths don’t rise to the nuclear level?
Buying Iranian Oil and Rare Earths may just be smart bomb stock piles.
Gold futures up oil futures down.
Meanwhile: Maya MacGuineas, president of the nonpartisan budget watchdog Committee for a Responsible Federal Budget, called the latest budget deal “a total abdication of fiscal responsibility by Congress and the President.”
What’s clear is the backdrop puts the $15.9 trillion Treasury market on course to balloon in the next couple of years.