Yuan devaluation draws new battle lines in US-China trade war

United States President Donald Trump has lashed out at China after the yuan was allowed to drop below the landmark seven-per-dollar threshold for the first time in more than a decade.

Trump’s trade war with China is ratcheting up as Beijing indicates it might be willing to tolerate more currency weakness.

“China dropped the price of their currency to an almost a historic low. It’s called ‘currency manipulation.'” the president tweeted. “Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!”

Monday’s sharp 1.4 percent drop in the yuan came days after Trump stunned financial markets by vowing to impose 10 percent tariffs on the remaining $300bn of Chinese imports from September 1, abruptly breaking a brief month-long ceasefire in the bruising trade war.

Beijing’s retaliation, the first time the yuan breached the seven-per-dollar level since May 2008 and the onset of the global financial crisis, could unleash a full-blown currency war – a dangerous new front in trade hostilities – analysts said.

The move was timed to allow markets to finally factor in concerns around the trade war, as well as weakening economic growth, sources told the Reuters news agency on Monday.

“We have had serious internal discussions, including issues such as the timing of the announcement, how to guide the market, and made some arrangements on such issues,” a policy source told Reuters.

“The regulators had a half-resisting, half-allowing idea for the yuan to fall past seven to the dollar.”

Global bond markets immediately felt an impact, with Bloomberg reporting German and UK yields falling to fresh record lows after China asked state companies to suspend imports of US agricultural products.

“The fact that [The People’s Bank of China] has now stopped defending 7.00 against the dollar suggests that they have all but abandoned hopes for a trade deal with the US,” Capital Economics Senior China Economist Julian Evans-Pritchard told Reuters.

‘Last line in sand’

In a statement on Monday, the central bank linked the yuan’s weakness to the fallout from the trade war but said it would not change its currency policy and that two-way fluctuations in the yuan’s value were normal.

“Under the influence of factors including unilateralism, protectionist trade measures, and expectations of tariffs against China, the yuan has depreciated against the dollar today, breaking through seven yuan per dollar,” the PBoC said.

The bank added that it expected the currency to rebound, saying it “has the experience, confidence and capacity to keep the renminbi exchange rate fundamentally stable at a reasonable and balanced level.”

The central bank set the yuan’s daily midpoint at 6.9225 to the dollar before the market opened, its weakest level since December 3, 2018.

“Today’s fixing was the last line in the sand,” said Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong.

“The PBoC has fully given the green light to yuan depreciation.”

It is thought other currencies may follow suit after the weakened yuan weighed down other markets. 

“We will see a new wave of depreciation among Asian currencies in the foreseeable future, and there could be further risk-off movements in the global markets,” Commerzbank economist Hao Zhou told the Financial Times. “It looks like a tsunami is coming.”

A second anonymous policy source told Reuters that the yuan’s drop would allow the market to let off steam after speculating for a year about when it would hit the seven-dollar mark.

“The depreciation is good to prevent mounting financial and political risks, including trade tensions with the US,” he said.

After opening the onshore session at 6.9999 per dollar, the yuan had weakened to 7.0313 per dollar by 07:10 GMT, down 1.27 percent on the day after earlier losing as much as 1.43 percent of its value. 

With the escalating trade war giving Beijing fewer reasons to maintain yuan stability, analysts said they expected the currency to continue to weaken.

“In the short-term, the yuan’s strength would be largely determined by the domestic economy. If third-quarter economic growth stabilises, the yuan could stabilise around 7.2 or 7.3 level,” Zhang Yi, chief economist at Zhonghai Shengrong Capital Management in Beijing, told Reuters.

The yuan’s weakness against the dollar was not confined to the onshore market. The offshore yuan also slumped, hitting a record low against the dollar of 7.1094 before rebounding to 7.0692 at around 07:12 GMT.

Trade weapon?

Monday’s slump below a key psychological threshold often defended by Beijing could further intensify the economic conflict between the US and China. Trump has long been critical of Beijing for manipulating its currency to gain a trade advantage, and further yuan weakness could draw Washington’s wrath.

An adviser to Beijing told Reuters that while China’s central bank had been preparing for the depreciation, the trigger was Trump’s unexpected announcement of further tariffs.

“This is not the PBoC’s tactics but is due to the US move,” he said. “The responsibility should [be] on the US side. The market was steady prior to the US tariff move.”

Capital Economics’ Evans-Pritchard believes Trump is likely to be angered by the PBoC’s explicit linking of Monday’s yuan weakness to the renewed tariff threat.

The flare-up in trade tensions has renewed global financial market concerns over how much China will allow the yuan to weaken to offset heavier pressure on its exporters.

“It appears the Chinese authorities no longer see the need to limit the tools at their disposal and that the currency is now also considered part of the arsenal to be drawn upon,” Rob Carnell, chief economist and head of research for Asia Pacific at ING, said in a note.

Analysts have previously said that authorities will keep depreciation in check due to concerns over potential capital outflows.

Despite slowing economic growth over the past year amid the intensifying trade war, China has not seen a rush of capital flight, thanks to capital controls put in place during the last economic downturn and growing foreign inflows into Chinese stocks and bonds.

In 2015, China stunned global financial markets by devaluing the yuan by two percent as its economy slowed. It burned through $1 trillion in foreign exchange reserves to steady it.

Shares were also battered on Monday, with plummeting Hong Kong equities weighing on the overall market, said Gerry Alfonso, director at Shenwan Hongyuan Securities Co.

Hong Kong’s Hang Seng index was 2.70 percent lower in afternoon trade as the city faced major disruptions, with a general strike paralysing parts of the Asian financial centre.

Alex Wang, Hong Kong-based analyst with Ample Finance Group, said worries over Hong Kong’s economy, which slowed more than expected in the second quarter, have been exacerbated by ongoing protests, with sectors including retail and tourism bearing the brunt of the impact.

The benchmark Shanghai Composite Index lost 1.62 percent for its weakest close since February 22, and the blue-chip CSI300 index dropped 1.91 percent.

Airlines were particularly hard-hit, pulling a transport sub-index down 2.72 percent.

Highlighting the widening effects of the trade tensions, agricultural commodities’ prices surged after a report that China had asked state-owned firms to halt imports of US agricultural products.

China soy meal futures rose more than two percent and Dalian iron ore futures dropped, hitting their weakest level since July, while London copper slumped to its lowest in more than two years.