23.08.2019 – Special report. The most important central bankers in the world meet in Jackson Hole. But while the world is focusing on the US Federal Reserve’s clear statements about the recession, a very different issue could become really important. China has apparently deliberately devalued the yuan against the dollar to an eleven-year low. This makes Chinese exports cheaper. The USA could shoot back in the currency war and also tighten the Fed.
Yuan at eleven-year low
Not a good sign for the ongoing negotiations in the customs dispute between China and the USA: The Chinese yuan has just slipped to a fresh eleven-year low against the dollar. Again, the yuan has crossed the red line of 7 against the dollar. Yesterday, Thursday, the Chinese currency fell to 7.09 against the greenback. The Chinese central bank as well as the international counterpart were able to fix the domestic yuan at par. Beijing is apparently deliberately devaluing its domestic currency in order to undermine the negative effects of US tariffs. A weak yuan makes Chinese exports to the USA cheaper. Incidentally, we had already predicted such a development at this point.
Beijing manipulates the yuan downwards
Beijing has therefore on the one hand thrown on the printing press; on the other hand, the Middle Kingdom is pumping a lot of foreign currency into the domestic economy via cheap loans and stimuli. The fact that the Chinese currency is falling more strongly against the Greenback than against other major currencies shows that there is a desired political step behind this, as the financial blog “ZeroHedge” judged. Obviously, large Chinese addresses are buying dollars and selling yuan.
The dollar is overvalued
By the way, large investment banks generally consider the dollar to be overvalued. In an excursus in June that very nicely illustrated the US’s possibilities against China, the Bank of America (BoA) supported repeated complaints by US President Donald Trump that the dollar was too strong. According to the BoA, the dollar is 13 percent too strong against the basket of other major currencies if the long-term average of the Real Effective Exchange Rate (REER) is used. The reason: the US economy is growing faster than most trading partners. There are three ways to weaken the dollar: 1) verbal intervention, 2) interest rate cuts, 3) direct intervention. 1) and 2) are over. Remains 3). In return, the US Treasury could instruct the New York Fed to intervene directly. What the NY Fed has only done three times since 1996: in 1998 it bought yen, in September 2000 it bought euro and in March 2011 it bought yen again.
Is the intervention coming now?
By the way, in the mid-1980s the “Plaza Accord” – so called after the Plaza Hotel in New York – intervened several times and devalued the dollar. Members of the club were the G5: USA, Germany, Japan, Great Britain and France. Is it time again? Standard Chartered pondered in July that the USA could use foreign exchange reserves of around 127 billion dollars to intervene, and that the Exchange Stabilization Fund (ESF) had a further 95 billion dollars at its disposal. However, a US intervention would trigger a reaction from other central banks and soften the effect. Especially since the G20 states had agreed on a waiver of devaluations; however, exceptions are permitted.
We think: The US will try to persuade the other countries to stand still in order to teach the Chinese a lesson. For which Jackson Hole should provide just the right ambience. The history of the Plaza Accord suggests that America does not want to go it alone.
Possible Renminbi counterstrike
And what if it will happen? Morgan Stanley said this week that the market underestimated the ease with which the US could intervene unilaterally. The US government alone has around 68 billion US dollars freely at its disposal; to activate additional resources, Congress or foreign partners would have to be involved. An intervention would probably not be so difficult, the Fed could simply buy up the entire, relatively illiquid international renminbi market, ponders R5FX, a trader specializing in foreign exchange. And he expects a strong reaction from Beijing in this case. China would probably have to attack its dollar reserves and probably sell US Treasuries in order to weaken its domestic currency again.
Washington is irritated
No matter whether uni- or multilateral and no matter in which amount: The fact that the Americans don’t watch the Chinese forever inactively, indicates among other things Tump’s Twitter tirades, which accused China (but also Europe) already several times of playing “currency games”. Last month US Treasury Secretary Steven Mnuchin announced that there was “currently” no change in US monetary policy, but that this could change in the future. At the beginning of this month, his ministry, the US Treasury, officially branded the People’s Republic as a currency manipulator after the Chinese central bank let the renminbi slide below the 7 mark against the dollar for the first time since 2008. And now the repeated affront – that can’t end well…
Beijing gets nervous
Even the Chinese seem to know what’s coming. The Financial Times just reported that a senior executive of a Chinese bank in London sees the possibility of intervention in the offshore Renminbi market. And the manager, who wanted to remain anonymous, warned of serious consequences. China will become a currency intervention as a hostile political act, this will swirl the markets around. The fallout will have unexpected consequences.
Our conclusion: the foreign exchange and bond markets could be really exciting in the future. China has opened the currency war, the USA is likely to react. And an open currency war would of course also have an impact on Wall Street, because an agreement in the customs dispute would be a long way off. Short or long – when trading CFDs, you should keep an eye on your regular market updates.
Bernstein Bank wishes you successful trades!
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