Why you should care
China’s currency is rising again after taking a hit, but its future rise remains uncertain.
When China’s currency “cracked seven” for the first time since the global financial crisis, some analysts fretted that U.S.-China trade tensions risked spilling over into all-out economic warfare.
But the yuan, also known as the renminbi, has rebounded in the months since it slid past the important seven to the dollar mark last August, which prompted the U.S. Treasury to brand China a “currency manipulator.” That rally continued on Wednesday after Washington deemed Beijing was no longer guilty of any foreign exchange funny business, with the renminbi hitting a more than five-month high against the greenback.
Strategists are now trying to figure out the next stage for the red-hot renminbi. Some warn that the rally could fade as long as a more comprehensive trade deal between the world’s top two economies remains out of sight. “I think year-end 2020 is going to see the renminbi not that much stronger than it is right now,” says Hannah Anderson, a global markets strategist at J.P. Morgan Asset Management in Hong Kong.
The Trump administration’s labeling of China as a manipulator last summer came after repeated accusations by the president that Beijing had weakened the renminbi to gain an unfair advantage for its exporters. China’s central bank sets a daily midpoint around which the onshore exchange rate for the currency can trade 2 percent in either direction. A separate, offshore version of the renminbi trades more freely in cities including Hong Kong and London.
It’s not like the trade war is over, done, dusted and settled.
Christy Tan, National Australia Bank
At about RMB 6.89 per dollar, however, the currency is now much weaker than it was before the U.S. first slapped tariffs on Chinese goods, underscoring how fraught the trade relationship remains.
Christy Tan, senior Asia markets strategist at National Australia Bank, says recent gains for the renminbi are partly due to seasonal factors unrelated to the ebbs and flows of global geopolitics. These include more demand from Chinese companies, which tend to convert their foreign currency holdings into renminbi to pay workers’ annual bonuses ahead of the holiday for the Lunar New Year in late January. That demand will soon wear off.
Investors may also be overly bullish on the significance of the so-called phase one trade deal, says Tan. That deal will see China boost imports from the U.S., while promising to better protect intellectual property rights. The pact, signed in Washington on Wednesday, halves existing U.S. tariffs on $120 billion of Chinese goods and takes the threat of new duties off the table.
However, tariffs of 25 percent on a separate $250 billion of Chinese exports will stay in place, with their future dependent on the trajectory of further trade negotiations. The deal also comes with no guarantee that China will immediately remove its own tariffs on U.S. goods. “It’s not like the trade war is over, done, dusted and settled,” Tan says.
U.S. President Donald Trump has said that talks over a phase two deal will start straightaway, addressing some of the deeper sources of economic tensions between the countries, including China’s use of industrial subsidies and cybertheft. But some analysts are skeptical. “We’re not optimistic about phase two,” says Tan. “That’s probably not going to happen any time soon and there’s no motivation on either side to actually start.”
Critics have accused the U.S. Treasury of using the charge of manipulation as a political tool to punish China and as a justification for placing more tariffs on the country’s goods.
J.P. Morgan’s Anderson says that while the designation opens the door to powerful U.S. measures to address trade imbalances, the real impact is on market sentiment, as investors worry it heralds a point of no return in U.S.-China tensions.
By early September 2019, the onshore-traded renminbi was down 4.5 percent versus the dollar for the year. But as trade negotiations resumed those losses narrowed and the renminbi finished the year down just 1.2 percent against the greenback.
Treasury Secretary Steven Mnuchin, announcing the removal of the currency manipulator tag this week, said that China had made “enforceable commitments to refrain from competitive devaluation.” Analysts are speculating what those commitments might be.
Helen Qiao, an economist at Bank of America, says there “could be [a line] drawn in the sand” as part of the phase one deal to cap any depreciation against the dollar. That suggests China may have agreed to some kind of floor on its exchange rate.
However, Qiao adds that the direction of the renminbi would also depend on China’s economy, which is flagging. Third-quarter growth in gross domestic product dropped to a three-decade low. But more recent monthly data has pointed to a pickup in exports and industrial production, raising the prospect of a turnaround in the world’s No. 2 economy. Regardless, traders doubt that Beijing would allow the currency to trade freely any time soon. “I think the most China could commit [to] is to not carry out any competitive devaluation,” says Frances Cheung, a strategist at Westpac.
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