The uncertainty is palpable, with cross-asset volatility ramping up as traders and investors anticipate increased price moves and pay up for portfolio protection. The need for capital preservation and a return of their capital is in play while shorting equity indices is working well for traders, with many looking to take advantage of the sheer lack of buyers of risk assets.
It’s the rate of change in asset pricing, which is just so important here. We know the disdain central banks have for fast-moving markets, and what we see across global equity indices, FX and bond markets suggests rising risks of calming rhetoric and promises of better liquidity dynamics in the near-term. In China, the markets have been on heightened alert around the daily CNY (yuan) fixing, which takes place daily at 11:15AEST, and where the PBoC ‘fix’ the USDCNY mid-point of relative to consensus estimates. Traders sense this is symbolic, where a fix higher than estimates sends a message to the White House.
A focus on the CNY ‘fix’
Importantly, the PBoC fixed the USDCNY mid-point at 6.9683 (+458p) today, and while that is higher, it was far lower than the consensus estimates of 6.9871. In a psychological way, the market saw this as a quasi-olive branch from Beijing…or, at least it didn’t inflame the issue further.
We have also seen the PBoC detail that they are to sell 30b yuan in short-term money market bills. By issuing this debt, it should have the effect of reducing liquidity, which has had a positive effect on the CNH, and we have seen better sellers in USDCNH.
The mere fact that USDCNH has fallen has seen brought out buyers off the opening low in Chinese equities, as we can clearly see in the China CN50 chart – an index that weights the top 50 Chinese mainland companies traded as a futures index on the Singapore futures exchange. In turn, we have seen S&P 500 futures follow suit and while still -0.8% in Asia trade, sits 1.2% off the earlier low. The ASX 200 has found stability, although a 2.5% sell-off in this market holds few positives.
The impact of tariffs on China’s economy
Economists are running the numbers, and the impact of Trump’s unexpected additional 10% tariff will likely have on the Chinese economy. Most estimate the new tax will reduce China’s exports by around 2.5% to 2.7%, and act as a headwind by some 50bp to growth, with an unwelcomed negative impact on employment. Perhaps I am too simplistic, but if Trump were to slap Australia or Europe with this tax, one would expect the AUD or EUR to be smashed. So USDCNH gaining 2% and we subsequently hear the US Treasury department label China a ‘manipulator’. It all seems just a bit too convenient.
If we go back to 2015 and look at the guidelines the US set for labelling a country a manipulator, it’s hard to categorically say China fall into that camp. Although, the script can change at any stage and the goalposts pushed any which way Mnuchin and Trump decide.
Is China really an FX manipulator?
The first criteria (of three), was for China to run a trade surplus of over $20b with the US, and on current numbers, it’s clear, that’s a huge fail for China here. The second is whether China has a current account surplus of over 3% of GDP, and as we see on the chart, China’s current account has been under this threshold since Q3 2011. The third and more contentious part is whether the Chinese have purchased foreign exchange of at least two per cent of GDP of a 12-month period. If we look at the trend in the CNY over the last year or so, if anything, the PBoC would have been buying their currency, and we see that China’s foreign exchange reserves have been stable for many months now.
Does this raise the threat of intervention?
The first question everyone is asking is what will be the repercussions on China of being labelled a ‘manipulator’. Most end up drawing the conclusion that the call modestly raises the probability of FX intervention from the US Treasury department. Intervention was already a hot topic in the markets anyhow, given Trump et al. have spoken out about their concern around the USD strength. However, it raises the point of what intervention could look like, what sort of size of USD flow we could feasibly see, and how much of a collaborative effort would there be between the Treasury Department and the Federal Reserve.
It seems logical that if we are going to going to see USD intervention, then we would initially see the Treasury department conduct a verbal exercise, scaring USD longs into reducing exposures. We are not there yet, and if we ever truly thought the US would intervene, then USDCNH would be below 7 in no time at all. USDJPY would be trading below the December flash crash of 104.70 and gold would arguably be north of $1500.
So, a theme to watch, but we have to think that if Donald Trump wants to use trade tariffs to get lower rates, then he’s pulling the right levers. Fed fund futures are pricing a 39% chance of a 50bp cut in September, although pre-China CNY ‘fix’ that stood closer to 50%, and there are nearly four cuts priced over the coming 12 months. If Trump wants a weaker USD, he is now shaping the narrative to intervene to weaken the USD in the period ahead. If he wants lower oil, he can work the supply/demand dynamic…it’s obviously a very dangerous economic game, as the changes in globalisation are having a lasting effect on the business landscape and will impact hard data at some stage.
However, to understand the circuit breaker we have to consider what Trump is wanting to achieve from these actions, and at this stage, while we could have seen a more punchy response from the PBoC on the CNY, Washington and Beijing are moving further apart; not closer.
Published by Chris Weston, Head of Research, Pepperstone