The FX market was surprised today when the Peoples Bank of China set the onshore USD/CNY rate much higher than anticipated at 6.9225, leading to the offshore USD/CNH currency pair extending gains through 7.00 – a level previously defended by the Chinese authorities concerned about capital outflows and one at which the pair has never traded above. Trading volumes are reported to be very high.
The move by China is seen as a direct response to US President Donald Trump’s imposition of more tariffs on Chinese goods and was fuelled by aBloomberg Newsreport that China had instructed local companies to put a halt to US agricultural products.
The USD/CNY cross traded to a high of 7.1310 before stabilising, apparently with no interference from China, while USD/CNH to 7.1095 before falling back to 7.0700. At the high this represented a 1.7% depreciation of the yuan.
Kit Juckes, head of FX strategy at Societe Generale says in a note to clients that the yuan is second to the euro in its weight in the Federal Reserve’s trade weighted dollar basket and is the biggest component of the European Central Bank’s trade weighted euro basket. “For the euro, it’s another weight to bear as weaker trade hurts an economy without enough growth to cope with a stronger (trade-weighted) currency,” says Juckes. “For the US president of course, with his concerns about the dollar being too strong, it is going to be a source of significant irritation. The debate about US FX intervention is going to heat up significantly.”
Meanwhile, noting that the line in the sand has been “wiped out”, InTouchFX analysts say, “It looks like the gloves are now off in the trade dispute and China has moved off the ropes and is throwing its punches.”
Although the impact on the US and that country’s response will be the headline issue, as noted by Juckes, a weaker yuan has a much wider impact. Morgan Stanley analysts observe that over the past couple of years, China has kept the yuan stable against the basket, but the RMB Trade Weighted Index is now testing the lower end of the range in play since 2017. “Investors may turn nervous, introducing another dose of volatility,” the bank says. “RMB stability helped to absorb volatility previously; allowing it to break lower will release volatility. USDCNY breaking 7 and China reiterating its firm stance on agricultural imports is likely to move focus onto a potential US response.”
Stock markets in Asia fell again and bonds rose, as did the yen, seen by investors as a safe haven play still, even though the Japanese government is yet to agree its own trade deal with the US and has a serious trade conflict continuing with South Korea.
Looking ahead, Craig Erlam, senior market analyst at Oanda, summarises the mood in markets at the moment, observing the timing of the move will spark speculation that this is being done intentionally as a counter-measure against US tariffs, which could cool relations further and make negotiations that much tougher. “We now await Trump’s response which I imagine will come via Twitter shortly,” Erlam says.