The US Treasury designated China a currency manipulator following President Trump’s tweet accusing China of currency manipulation after USDCNY broke above the key threshold of 7. This is the first time the Treasury has named a currency manipulator since 1994 (the last time against China too, incidentally).
The currency manipulator labelling is extraordinary as China does not meet 2 of the 3 US Treasury criteria for a currency manipulator, namely a current account surplus greater than 2% of GDP and engaging in "persistent, one-sided" FX market intervention in the past 12 months. The next “Foreign Exchange Report” report by the US Treasury is due on 15 October, but they have acted ahead of schedule.
It is fairly standard for currencies to weaken in response to tariff shock. China had previously defended the USDCNY from breaking above 7 to prevent hindering trade talks. But the diminishing prospects of a near-term trade deal following Trump’s announcement that it will levy another 10% tariff on USD300bn of imports from China means a “goodwill gesture” on CNY is no longer necessary. The move to suspend buying of US agricultural products, which strikes at the heart of Trump’s support base, is also indicative of the hardening China stance.
The US Treasury’s move to name China a currency manipulator marks a significant, symbolic escalation of the US-China trade conflict, heightening fears that trade tensions could spiral out of control, with the tit-for-tat measures increasing the risk of global recession. The 3m-10y US Treasury yield curve, which is currently most inverted since early 2007, sends a loud recession warning.
The practical implication of naming China a currency manipulator is, however, modest. The label doesn't provide Trump with any new, aggressive near-term options for imposing penalties on China that the Section 301 tariffs don't already provide. The US will now have to talk to the IMF and try to persuade them of its view on Chinese currency manipulation. It is not clear the IMF will agree.
On the currency front, it is déjà vu all over again. A replay of the market dynamics from the May round of trade-war escalation with trade chills spilling to other Asia currencies and China-sensitive G10 currencies could be a reasonable reference point.
USDCNY breaking 7 does not necessarily mean the People’s Bank of China (PBoC) intends to let the CNY depreciate freely. The USDCNY fixing by PBoC today at below 7.0 (i.e. 6.9683) is an important signal or the first step in trying to slow the ascent in USDCNY to avoid an onshore panic creating more capital outflow pressure. A possible tightening of capital controls to help contain bouts of exchange rate weakness will also be closely watched.
That said, if the trade war escalates further and depreciation pressure on the CNY intensifies, we expect the CNY to weaken. The simplistic tariff math – the implied level of USDCNY required to offset US tariff -- would suggest scope for USDCNH to go to 7.30-7.40 if the 10% on USD300bn of imports from China comes into effect and to 7.80-7.90 if the 10% tariff is raised to 25% on these goods.
Naming China a currency manipulator may be a political expression aiming for USD weakness. The move will feed concerns that the US may take further steps to directly weaken the USD, up to and including direct intervention on the exchange rate. Trump’s pressure on the Fed to cut rates aggressively point in the same direction.
Disclaimer applicable to recommendation
There are a range of options available to US authorities to oppose USD strength, ranging from labelling countries manipulators, ‘twittervention’, the use of currency clauses in trade agreements, the imposition of countervailing duties on countries which have competitively devalued their currencies and direct intervention by selling USD. With the US administration now pursuing the first three out of these five options, the market is likely to price in a higher likelihood that the US will engage in other measures to weaken the USD. The risk of US currency intervention is low but increasing.
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