It’s probably fair to say that when it comes to the onset of a global currency war, the proverbial horse has left the barn. But just in case it’s not too late, the PBoC on Tuesday “advised the United States to rein in its horse before the precipice”.
Beijing also said Trump should “be aware of his administration’s errors, and turn back from the wrong path”. That path, if the US continues to travel down it, will “severely damage international financial order, cause chaos in financial markets [and] prevent a global economic and trade recovery”, the PBoC went on to warn.
The statement, posted to the central bank’s website, came on the heels of the US Treasury’s decision to brand China a currency manipulator.
The question now is what comes next. Obviously, China’s weaponization of the yuan on Monday and Trump’s move to brand Beijing a manipulator mean talks set for September are in jeopardy and the chances of a deal being struck in the near- to medium-term are essentially zero.
The PBoC on Tuesday set the yuan fix stronger than expected, in a bid to calm markets, but any respite is likely to be fleeting. As noted here on Monday evening, the yuan would need to fall to near 7.40 to offset the effects of the proposed next round of tariffs and near 7.90 to counteract any further escalation (i.e., if Trump were to slap a 25% tariff on the remainder of Chinese imports).
The White House is pressing the Fed to cut rates to help in the struggle, but Jerome Powell is understandably reluctant to get on board. He may ultimately have no choice, though. If the bond market continues to price in aggressive rate cuts, disappointing those expectations risks tightening financial conditions, and in the event Trump instructs Steve Mnuchin to actively intervene in the FX market using the ESF, the Fed would have to openly break with the administration in order to avoid participating.
But what about the PBoC? Will they cut now that the Fed has cut? It’s certainly possible, although what form any further easing would take is up for debate.
“A review of the China-US policy rate movements over 2015-19 shows that as the trajectories of the two economies diverged last year, China’s monetary policy was largely driven by domestic considerations”, Barclays’ Jian Chang, the only analyst on Wall Street to predict the PBoC’s last round of benchmark cuts, said Tuesday. “The PBoC followed the Fed on four of the five times the US hiked rates between December 2016 and March 2018, a period when China was undertaking its de-leveraging campaign”, she went on to say, referencing the series of OMO hikes the market became accustomed to whenever the Fed moved.
But more recently, PBoC policy has diverged, and Yi Gang suggested in July that China will focus on domestic economic considerations, not the movements of the Fed.
This is complicated by the PBoC’s efforts to reform China’s multi-tiered rate regime. “The PBoC continues to reiterate its commitment to merging the so-called dual track interest rates [and] phasing out the benchmark lending rate, replacing it with a market-based loan pricing rate”, Barclays goes on to write, recapping recent news flow around the reform effort.
“While the timing and mechanism for the phasing out of the benchmark lending rate remains uncertain, we think a move is likely in the coming months”, the bank goes on to say. Basically, China needs to get the dark blue line in the following chart down.
Irrespective of how that effort pans out, China will likely need to ease in September, especially if Trump goes ahead with the tariffs planned for the first of next month.
As ever, Beijing is attempting to keep a lot of plates spinning. It’s a Herculean task.
“Looking ahead, the PBoC will certainly have to deliberate over its multiple objectives, including balancing the cyclical priorities (growth, inflation, CNY and financial stability) and the structural challenges (leverage, housing)”, Barclays goes on to say, summarizing a balancing act so difficult that one is yet again left to marvel at the PBoC’s ability to manage it all since 2015.
So, how will China go about threading the monetary policy needle next month given i) the looming tariff threat, ii) the looming Fed meeting, and iii) the effort to revamp the entire rates regime?
The answer is: Nobody knows for sure. But if you’re inclined to listen to analysts, Jian Chang is as good as you’re going to do when it comes to the PBoC. Here, in brief, is her assessment:
All else equal, a further tariff hike in September as threatened by President Trump will add to the probability that the PBoC could lower policy rates (including OMO and MLF rates), in our view. We think a possible timing could be after the 1 September tariff hike deadline (according to President Trump’s tweets on 1 Aug, although timing may change because as the next day he mentioned the possibility to delay) but before the FOMC decision (18 September). Additionally, we think the PBoC could take that opportunity to announce the new LPR pricing mechanism and guide non-mortgage lending rates lower.
If you thought the Fed’s job was hard right now, do take a moment to try and wrap your head around all of the above on the way to imagining what it must be like for the PBoC.
For fun, here is the translated version of the PBoC’s statement
On August 6, Beijing time, the US Treasury Department listed China as a “currency manipulator”. China deeply regrets this. This label does not meet the quantitative standards of the so-called “currency manipulators” formulated by the US Treasury. It is a wayward unilateralism and protectionist behavior that seriously undermines international rules and will have a major impact on global economic finance.
China implements a managed floating exchange rate system based on market supply and demand with reference to a basket of currencies. The RMB exchange rate is determined by market supply and demand, and there is no problem of “currency manipulation”. Since August this year, the RMB exchange rate has depreciated to a certain extent, mainly due to the changes in market supply and demand and international exchange market fluctuations in the context of changes in the global economic situation and increased trade friction. It is driven and determined by market forces. The People’s Bank of China has always been committed to maintaining the stability of the RMB exchange rate at a reasonable and balanced level. This effort is well known in the international community. According to the data released by the Bank for International Settlements, from the beginning of 2005 to June 2019, the nominal effective exchange rate of the RMB appreciated by 38%, and the real effective exchange rate appreciated by 47%. It is the strongest currency in the G20 economies and is also appreciated globally. One of the largest currencies. In the just-concluded IMF’s consultations on China’s Article IV, the International Monetary Fund pointed out that the RMB exchange rate is generally in line with fundamentals. In the 1997 Asian financial crisis and the 2008 global financial crisis, China has been committed to maintaining a stable RMB exchange rate, which strongly supports the stability of the international financial market and the global economic recovery. Since 2018, the United States has continuously escalated trade disputes. China has always insisted on not engaging in competitive devaluation. China has not used the exchange rate as a tool to deal with trade disputes.
The United States disregards the facts and unreasonably affixes China with the label of “currency manipulators”, which is a behavior that harms others and harms oneself. The Chinese side firmly opposes this. This will not only seriously undermine the international financial order, but also trigger financial market turmoil. It will also greatly hinder international trade and the global economic recovery, and ultimately will suffer from it. This unilateral act of the United States also undermines the global multilateral consensus on exchange rate issues and has a serious negative impact on the stable operation of the international monetary system. The Chinese side advised the US to leap over the cliffs, get lost, and return to the correct track of rationality and objectivity.
China will continue to adhere to a market-based supply and demand, with reference to a basket of currencies to adjust, a managed floating exchange rate system, to maintain the basic stability of the RMB exchange rate at a reasonable and balanced level. (Finish)