The renminbi has fallen past 7.0 per US dollar after the market digested the implications of the move by US President Trump to levy a 10% tariff on another USD 300 billion of Chinese imports, pushing the Chinese currency to a level not seen since the 2008 Global Financial Crisis and one which China's central bank had been defending.
- Chinese authorities tolerate weaker renminbi
- Move takes trade conflict to a new level
- US increases pressure on China with more tariffs, but Chinese are still playing it slowly
- Beijing's focus is on boosting domestic demand
Exhibit 1: Renminbi weakens through level of RMB 7 per USD for the first time since 2008Source: BNP Paribas Asset Management, Bloomberg, 5 August 2019
In my view, the flare-up in the trade war risk reduces the probability of a temporary agreement before year-end to less than 50% (from 60%).
If tensions rise further, it will render any forecast of the USD/RMB exchange rate worthless as the renminbi has become increasingly sensitive to changes in sentiment.
It is still uncertain how the trade-war dynamics will unfold, given Mr. Trump’s unpredictable tactics. It seems that his latest move took place despite objections from virtually everyone at an Oval Office meeting except Peter Navarro.
What is certain, in my view, is that a strategic recalculation by Mr. Trump of his near-term negotiating tactics is underway along with a revaluation of a recent trade-policy shift by China. The upshot of these changing dynamics is manifested in the weakening of the renminbi.
Trump’s strategic re-calculation
It seems that Preisdent Trump is willing to take a calculated risk of intensifying his offensive tactics to force a deal out of China before the 2020 elections. Financial markets, however, fear that this tactic may actually hinder rather than help the US economy and, hence, his re-election chances as the new tariffs will hit consumer-related products and, thus, the US consumer more than China.
Revaluation of China’s negotiating tactics
While Mr. Trump may be anxious to get a deal done before the election, China is playing it slowly. As I argued recently, China has hardened its position since late May when the leadership reached a consensus for fighting a prolonged trade war with the US even at the cost of more pain to the domestic economy.
China’s new strategy is to exhaust Mr. Trump’s energy with a rotating tactic of fighting and negotiation – after each round of fighting, China will negotiate with the US. If the negotiation fails, it fights again; and negotiate and fight… The circle goes on until the Americans are exhausted and come to an agreement. Beijing will up the ante after each round of failed negotiations to make the settlement conditions tougher.
Mr. Trump would not seem to be able to afford to play this game with China; he cannot afford to weaken the US economy and stock markets before the election.
But if he wants to continue to play hard ball and backs away from promises to issue licenses to Huawei’s US suppliers, the odds of negotiations breaking down will likely rise significantly.
Even if there is a temporary trade deal, the drive to decouple the Chinese and the US economies, especially by the Trump administration, looks set to continue. The Sino-US tech competition is here to stay with short-term negative implications for the tech sector.
Boosting domestic demand is Beijing's primary policy
Beijing has its “nuclear option” to retaliate against the US through non-tariff barriers. But this, in my view, is a secondary priority. Fighting the trade war by boosting domestic demand is the policy focus. Beijing will continue to implement targeted easing measures. Expect more cuts in the RRR and lending facility interest rates (such as the MLF, SLO, SLF and PSL) in coming months. Such moves would put downward pressure on Chinese bond yields and corporate spreads if credit default risk stabilises.
While I am still of the opinion that Beijing does not have an explicit policy of pursuing a devaluation, the People's Bank of China's tolerance of a weak renminbi resulting from market forces may unintendedly result in a tit-for-tat escalations of currency devaluations.
On a more positive note, if a weak currency (that is to say, above RMB 7 per USD) is a result of China’s measures to boost growth, this may cushion regional and even global growth as Chinese demand has played a bigger role in sustaining other countries’ growth recently.
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