China Studying Yuan Devaluation As Retaliation To Trade War; CNH Slides

Last week, with the tit-for-tat Chinese trade war escalating following Trump's threat to raise Chinese imports tariffs by another $100BN, we said that it is time to buy some Yuan puts, ahead of a potential Chinese devaluation.

Overnight we got a clear lesson why this highly convex trade would be prudent in the current trade war environment, when Bloomberg reported at 3am EDT that China is "evaluating the potential impact of a gradual yuan depreciation" citing people familiar with the matter said, as the country’s leaders are weighing their possible responses in the escalating trade war with President Trump.

As a reminder, a devaluation was one of the "nuclear" retaliation options listed here on Friday, and is certain to provoke an even harsher response by the US. Still, this appears not to have spooked senior Chinese officials who are reportedly studying a "two-pronged analysis of the yuan that was prepared by the government": one part looks at the effect of using the currency as a tool in trade negotiations with the U.S., while a second part examines what would happen if China depreciates the yuan to offset the impact of any trade deal that curbs exports.

Still, the analysis doesn’t mean officials will carry out a devaluation, which would require approval from top leaders.

In kneejerk response, both the onshore and offshore yuan weakened as much as 0.2% to 6.3186 per dollar in onshore trading and 6.3211 for the offshore pair.

At the same time, the dollar climbed against the yen and other EM currencies in response: "USD seems to be regaining some ground on the back of the headline" said Valentin Marinov, head of G-10 FX research at Credit Agricole. “The story seems to suggest that the Chinese are discussing the idea of FX depreciation rather than work on an imminent change in FX policy."

Ironically, while Trump has bashed China on the campaign trail and more recently on Twitter, for keeping its currency artificially weak, the yuan has gained about 9% against the greenback since he took office and has been steady in recent weeks despite the escalation of trade tensions between the world’s two largest economies, prompted by a weaker dollar. The Chinese currency touched the strongest level since August 2015 last month.

That said, w\hile a weaker yuan could help President Xi Jinping shore up China’s export industries in the event of widespread tariffs in the U.S., a devaluation comes with plenty of risks, according to Bloomberg:

  • It would encourage Trump to follow through on his threat to brand China a currency manipulator,
  • it would make it more difficult for Chinese companies to service their mountain of offshore debt,
  • It would undermine recent efforts by the government to move toward a more market-oriented exchange rate system.
  • It would expose China to the risk of local financial-market volatility, something authorities have worked hard to subdue in recent years. When China unexpectedly devalued the yuan by about 2 percent in August 2015, the move sent shock-waves through global markets.

“Is it in their interest to devalue yuan? It’s probably unwise,” said Kevin Lai, chief economist for Asia ex-Japan at Daiwa Capital Markets Hong Kong Ltd. “Because if they use devaluation as a weapon, it could hurt China more than the U.S. The currency stability has helped to create a macro stability. If that’s gone, it could destabilize markets, and things would look like 2015 again.”

Which is why many are unconvinced China will actually follow through.

China is unlikely to resort to a devaluation unless it exhausts its other trade-negotiation tools, said Frances Cheung, head of Asia macro strategy at Westpac Banking Corp. in Singapore. The more likely scenario is that the two countries will reach a compromise and China will continue to liberalize its capital account, added Zhou Hao, senior Asia emerging markets economist at Commerzbank AG.

“There are many measures they can take before resorting to this tool,” said Ken Peng, an investment strategist at Citi Private Bank in Hong Kong. “Using yuan depreciation is like sacrificing 800 soldiers of your own to kill just 1,000 enemies.”

Perhaps, although as we noted yesterday, one of the measures suggested by China's Global Times is to attack the US stock market. It is not clear if that is necessarily a "better option." It also doesn’t mean market-driven yuan weakness is off the table. The average forecast among analysts tracked by Bloomberg calls for the currency to drop slightly by year-end to 6.38 per dollar.

“There is room for a near-term yuan correction given how much the currency has gained since last year,” said Ken Cheung, a currency strategist at Mizuho Bank Ltd. in Hong Kong. “China would allow market-driven yuan weakness if sentiment fluctuates on trade war concerns. But it’s unlikely for the authorities to engineer another round of significant one-off devaluation.”

Speculation aside, a key event will take place in under 24 hours when traders looking for clues on President Xi’s thinking will get an opportunity to hear him speak personally. On Tuesday he’s scheduled to address the Boao Forum for Asia - China’s answer to Davos - on the tropical island of Hainan.

Meanwhile, courtesy of Bloomberg, here are several research analyst responses to the story that China may devalue its currency:

Citi Private Bank (Ken Peng, investment strategist)

  • China likely won’t devalue the yuan, as further weakness would lead to significant capital outflows, which the government tried to rein in over the past few years
  • Cost of such a measure outweighs benefits; using yuan depreciation is like sacrificing 800 soldiers of your own to kill just 1,000 enemies
  • There are many tools the government can take before resorting to yuan depreciation, such as more tariffs, canceling orders from American companies and even selling U.S. Treasuries
  • The yuan may weaken due to market forces, as it’s rallied too quickly recently and the U.S.-China interest-rate gap has narrowed

Westpac Banking Corp. (Frances Cheung, head of Asia macro strategy)

  • China is unlikely to target a certain level for the yuan in response to the trade conflict when other options aren’t exhausted
  • A stable yuan is in China’s interest, it helps promote foreign interest in yuan assets
  • Response pretty much focuses on trade, though this may be extended to other bilateral flows as China doesn’t import that much from the U.S.
  • Prudent for policymakers to carry out studies such as this from time to time

Daiwa Capital Markets (Kevin Lai, chief economist for Asia ex-Japan)

  • Would be unwise for China to devalue the yuan, as that could hurt China more than the U.S.
  • Currency stability has helped create macro stability; if that’s gone, it could destabilize markets, and things would look like 2015 again

Mizuho Bank (Ken Cheung, strategist)

  • There’s room for near-term yuan correction given how much the currency has gained since last year
  • It’s unlikely China will engineer another significant one-off devaluation -- the cost would be too big as it would spark depreciation concerns and go against China’s target to open its market and globalize the yuan

Commerzbank AG (Zhou Hao, economist)

  • Yuan depreciation is a measure China would have to prepare, and there’s nothing unusual for it to be considered in a trade war
  • If China and the U.S. fail to strike a deal, China would definitely weaken the yuan
  • More likely scenario is for the two countries to compromise and China to liberalize capital account

 

 

 

Comments

Mementoil BritBob Mon, 04/09/2018 - 06:23 Permalink

I fail to see what good will China get by devaluating its currency.

I mean - if it costs more to export to the US due to tariffs, while the cost of production is lowered due to Yuan devaluation, the Chinese exporters may be able to maintain their market share. But this will be at the expense of the Chinese consumer, whose purchasing power is diminished. In other words - cutting off your nose to spite your face.

What they should have done is to say - fine Mr. Trump, levy your tariffs! Their exporters would have no choice but to divert some of their products to the local market, which would increase the standard of living in China. At the same time the American consumer would have to pay more for imported goods and they would be the ones to bear the cost of the tariffs! 

In reply to by BritBob

Theosebes Goodfellow kralizec Mon, 04/09/2018 - 11:01 Permalink

China has to put on its big-boy pants and stop monkeying with their currency if they ever hope to compete in the world reserve game. The statement that the yuan and the U$D are mortally interlinked is true and the sooner both sides suck that up the better the world will be. 

Both sides have unmanageable debt. That will be the death of them, not the currencies.

In reply to by kralizec

William Dorritt Mementoil Mon, 04/09/2018 - 08:25 Permalink

China's goal has been to steal all US tech, all US factories with companies like Boeing as the last wave, then discard the US the way a spider discards the sucked dry corpse of it's prey.

 

The standard of living or wants of the Chinese people don't factor into the equation for world dominance by a Communist power, a goal shared by the progressive Marxist democrats in the US.

In reply to by Mementoil

Eatabanker bluez Mon, 04/09/2018 - 07:14 Permalink

Yo, slow down on the drama and caffeine. 

If we are "fucking idiots"

A- Would we be smart enough to not give a shit about what you have to say?

B- Would we dumb enough to give it a shit about what you have to say? 

The world will be here tomorrow, or it won't. Nothing you or I can do about that. Tomorrow, try decaf. Maybe jerk off before breakfast a bit more. Then if practice does indeed make perfect, you'd be the perfect jerk off.  

 

 

In reply to by bluez

BraceforImpact Mon, 04/09/2018 - 06:30 Permalink

A trade war is mutually destructive long term, and now you each have further devalued currencies. If you want a preview of what's mathematically inevitable, look at Venezuela, then multiply the magnitude a few times. We're much worse.

 

Banks know what's coming, most people don't and don't care.

Mementoil lester1 Mon, 04/09/2018 - 06:59 Permalink

If you think Tariffs will help the common American, then you are kidding yourself.
Sure, this may bring back some production home, which will create good manufacturing jobs. But it takes years to create the necessary infrastructure, and re-learn all the knowledge which was lost. In the mean while, the American consumer will have to pay much higher prices for imported goods, because there are no local alternatives! This will lead to massive inflation!

In reply to by lester1

DingleBarryObummer Mon, 04/09/2018 - 06:34 Permalink

This is all just rhetoric and propaganda to cultivate anti-Chinese public sentiment.  The moneychanger cabal that owns the President will need to make war with China now that they've launched their gold backed petro yuan.  Gaddafi and Saddam tried similar things and war followed. 

Last of the Mi… Mon, 04/09/2018 - 06:42 Permalink

They WILL devalue. Their CB policy is like ours. We can make our citizens work for nothing save nothing and live in caves for the sake of more sales with a devalued dollar. QE, the gift that keeps on giving. generation after generation after generation.

truthalwayswinsout Mon, 04/09/2018 - 06:47 Permalink

If the Yuan devalues there goes all its dreams of using the Yuan as any kind of reserve currency.

If it devalues the tariffs will go correspondingly higher and there will be 10-30 more potential allies for a trade embargo including the EU.

In fact, if it goes higher a kicker will be introduced that simply puts a tariff on everything from a devaluation and not just the products that have tariffs.

If it devalues, the end of the Chinese Government will be just around the corner.

 

 

 

 

Money_for_Nothing Mon, 04/09/2018 - 06:52 Permalink

A devaluation would have nothing to do with US tariffs. US tariffs are paid in USD. Devaluation would just recognize that China has a debt problem and is using the current situation as cover to devalue. China doesn't have enough USD to cover Yuan at the current exchange rate. China is bleeding out financially.

1952angus Money_for_Nothing Mon, 04/09/2018 - 07:04 Permalink

Falling demand for goods in the western economies, due to contracting customer spending power because of zero interest rates, leads falling demand, which results in falling dollar reserves, which means falling currencies in export driven economies ie china. The yuan is going down against the dollar and chinese goods are going to get cheaper.  These tariffs will cause all imports to the us to rise in price, regardless of where they originate.

The problem is that the us debt is going up so the us has to keep selling more bonds and china will be buying less and thats the rub. So the fed will have to increase its us bond purchasing. The us debt is going to accelerate 

In reply to by Money_for_Nothing

Money_for_Nothing 1952angus Mon, 04/09/2018 - 07:12 Permalink

"The dollar is going up in value"
Not if Congress has anything to do with it. The Fed is raising interest rates. Banks need the money. Treasury can create as many bonds as the Fed needs to implement policy. At some point the people in the rest of the world will stop working if they don't get to keep more of their output. China is near that point.

In reply to by 1952angus

Davidduke2000 Mon, 04/09/2018 - 06:54 Permalink

the us keeps pushing for an artificial strong dollar yet it keeps whining to China to buy more american goods that are not worth the money.

At a young age, I was buying only GM, them moved to ford when we lost our car manufacturing facilities due to NAFTA,  I moved to Toyota and BMW, what a difference in quality and superiority, sorry american cars are not match for German and Japanese, NAFTA destroyed Canada's car industry and opened my eyes to better cars.

I have no desire to purchase anything american, I cashed in all my usd since 911 as the us customs and some people became too arrogant even to peaceful Canadians, sold my house in Florida and my Carver in NY, I do not miss the place at all as Cuba and the Dominican republic do the job for the winter and much cheaper .

Money_for_Nothing Mon, 04/09/2018 - 06:56 Permalink

"look at Venezuela"
Well the US is more Socialist than it use to be. But it has a freer society than either Venezuela or China so it has that going for it. I'm betting China goes Venezuela before US goes Venezuela. Sorry for you if you have any money left in China.

buzzsaw99 JPMorgan Mon, 04/09/2018 - 07:03 Permalink

if they devalue 10% in response to a 10% tariff that's a win-win for the usa.  it squeezes their margins while keeping consumer prices in the usa the same and trump collects the tariff money.  they can't win that game.  they already have an yuan outflow problem and domestic inflation disgruntlement which will only get worse.

In reply to by JPMorgan

1952angus buzzsaw99 Mon, 04/09/2018 - 07:14 Permalink

its got nothing to do with margins except where they are importing raw materials and adding extra value. (uS consumers pay for the tariffs on increased shop prices), but this is a small part of the costs involved when manufacturing and re-exporting. They will be exporting to none tariff affected countries and transhipping to the us labelled as bangledesh or whatever and sold at higher prices. bad news for the the american consumer who is going to get squeezed.

 

In reply to by buzzsaw99

To Hell In A H… buzzsaw99 Mon, 04/09/2018 - 07:29 Permalink

The Chinese are playing a Zero Sum Game. The dollar is bust and effectively worthless with a decade of Q.E. The USSA is bankrupt. It has nowhere near the gold reserves it claims it has, as it has been rehypothecated to the moon and back, with 47 claims of gold for every once physical ounce thanks to ETF's, along with other bogus financial products and instruments. 

There are over 1 billion people in Africa, with that number set to double, by 2060. What fucking purchasing power does the USSA really have, outside of a rigged international finance system and hype? Don't buy Chinese products and where will you purchase them from? Make them yourself? With your wage structures, sell them to who? 

The Chinese are politely telling the Americans, that they don't need them. They are building a silk road and integrating trade routes. While the Americans are bombing and stealing resources. 

In reply to by buzzsaw99

To Hell In A H… Mon, 04/09/2018 - 07:10 Permalink

This trade war is a genuine eye-opener for many Americans on ZH, and a true visible indication that Uncle scam no longer has the economic power and clout they themselves thought he had.

The Chinese have shown uncle scam, you cannot bully, mould, coerce, threaten, or sanction them into following their dictates. Trump has no cards to play.  The Americans have been brainwashed into believing the world will implode and end, without their input and economic purchases from the bogus and bankrupt King dollar, aided by the Petrodollar system. 

The slow dawning that the USSA are not the only nation of exceptionalists and that in reality they are a parasite nation, living off the resources of other nations, purchased by a currency that in reality has no value, propped up by the worlds foremost criminal and fraudulent financial system, is a hard fact to take all at once.

So you have Trump playing the lead role of Uncle scam, calling out the Chinese and the Chinese have politely replied, that the emperor has no fucking clothes. The joke is the Americans don't have to cold turkey their demise, and despite their grotesque treatment of the Africans and the Middle east, they can ease their demise really well, by going into partnership, building a legacy, transferring non-IP technology and helping them develop over the next 5 to 6 decades, instead of killing and robbing them blind and taking for themselves. Alas, a leopard rarely changes its spots and the USSA will realise its allies and friends outside of a core group of 10, has been built on fear and coercion. 

The USSA has no real allies. My 8 years in international politics taught me that and boy is the next few generations of Americans going to suffer for the mistakes and actions America has conducted over the last 150 years. To say Uncle scam has abused its position and friendships, is the understatement of the century.

Money_for_Nothing Mon, 04/09/2018 - 07:19 Permalink

Every country in the world makes noises like the US has damaged it mightily by just not trading with that country. Remember when Vietnam kicked the US out. Wonder how their War Vets feel now? Making shirts for the US market. China in North Korea (1953). Trump is correct and all the others are lying in this area. China has screwed itself.

Ethelred the Unready Mon, 04/09/2018 - 07:43 Permalink

If left to natural economic forces, the Yuan wants to go up, up, up.  It would drop only if money fleeing China exceeded China's current account surplus.   So far the Chinese have been holding the Yuan down by govt. buying of US financial assets (mostly Treasuries, etc.) and trying to block capital flight.  

So to get the Yuan to drop Xi would have to 

1. Close the trade surplus, or

2. Allow even more Chinese to move their funds out of China

3.  Buy even more Treasuries.

OR a bit of all three.  None of which are IMHO palatable to Xi.

Cutter Mon, 04/09/2018 - 09:21 Permalink

China is going to devalue. This trade spat gives them the perfect reason, without admitting their really doing it because of their debt problem. The analysts cited here are in denial, because of what devaluation will mean for the rest of the world. And China is going to start selling treasuries, not too much, just enough to send the fear of God to the US Treasury. 

Trump is right in trying to readjust our trade with China, they have been taking us to the woodhouse for years. But he is throwing rocks from a $21 trillion glass house and when China, and Russia, start throwing rocks back from their own glass houses, we will see how much pain we can take. I suspect not much. 

Dorothea Binz Mon, 04/09/2018 - 09:59 Permalink

while I applaud Trump's attempt to bring China to the table, they really don't have to come. Most ridiculous thing Trump EVER said was a trade war would be easy to win. The truth is China truly holds all the cards on that one, unless the rest of the world was to suddenly  ally with the US against China.  No doubt there are plenty of countries that agree China is a cheat, but they don't have the juevos to do anything even with the US taking on most of the risk. The reason China holds all the cards is because China's leaders don't have to deal with elections like Trump and Republicans will. Who can say with a straight face that Democrats won't use the trade war to gain an advantage come election time? US consumers are the wild card in all of this. China can always play the long game better than the US. But something in me is still hopeful China will want to give the US an out and balance out their illegal mercantile tactics.