President Trump's tweets last week announcing the end of the tariff truce signaled a new phase in the U.S.-Chinese tensions. China responded as did investors. I was fortunate to have been invited to the Bloomberg set to discuss the issues of the day.
In this two-minute clip, I suggest there will be far-reaching implications for investors. World growth is getting marked down as deflationary forces strengthen. The dollar-yuan was a low vol pair, and it still is, but considerably higher than it was--from a two-year low near 3.4% to almost 5.6% earlier today. The trade conflict will produce more collateral damage. South Korea's KOSDAQ fell 7.5%, and the won was weaker than the onshore yuan (barely).
I suggest China did not drive the yuan down. It stood away and did not resist market forces as it had been. Consider with today's loss the yuan is off about 2.5% this year. In the region, both the South Korean won and the Taiwanese dollar have depreciated more (8.5% and 2.9% respectively). The MSCI Intl Emerging Market Currency index was sold through its 200-day moving average at the end of last week and was rolling over even before the end of the latest tariff truce. I think that given the concerns about growth and other macro-considerations, that if the yuan were a floating currency, it would have sold odd considerably more than it did.
The U.S. response to China's move is awaited. There is little doubt that it will extend beyond the tweet that was really another call for the Fed to ease policy. Some trilemma seems to be at work. Trump can get what he wants in terms of more Fed cuts and a weaker dollar, but not a stronger stock market at the same time. According to the CME's model, there is about a 47% chance priced into the fed funds futures strip of three or more rate cut still this year. A week ago it was around 18% chance. U.S. stocks are getting pummeled. The S&P 500 is approaching 2843, the (61.8%) retracement objective of the rally since early June, after gapping sharply lower at the open. That opening gap will eventually be important, but now the focus in on the downside and below the retracement objective is the 200-day moving average near 2790.
The PBOC fix tomorrow, or the setting of the dollar reference rate will also be scrutinized by participants for clues into Chinese thinking. China wants to avoid a repeat fo the vicious cycle of 2015. At the same time, the Trump Administration tries talking the dollar lower and threatens intervention. We do think there was an olive branch offered but doubt that the U.S. can accept it. As we noted before, a Chinese official was quoted saying that the CNY7.0 is not like an age that cannot be returned to. It suggests China does not particularly want to go down this route, but the U.S. actions leave it little choice. Note too, China is facing some difficult choices in Hong Kong and the 70th anniversary of the Revolution is around the corner (Oct 1).