At Fathom, we have argued that tensions between the US and China should not be referred to as a trade war, because wars end. Events over the past few weeks, which have seen Donald Trump end a month-long truce by threatening additional tariffs on China’s exports, a subsequent depreciation of the renminbi and a prompt branding of Beijing as a currency manipulator by the US administration only lend weight to that long-held view. Consequently, while the escalation in trade tensions have unnerved financial markets, triggering a reassessment of the prospects for both global growth and a currency war, it is of little surprise to us. In fact, we have continued to argue that a weaker currency is part and parcel of China’s current growth strategy, devaluing in order to cushion the economic slowdown and offset the impact of tariffs.
As highlighted in the chart, Beijing has fired warning shots, depreciating the currency whenever Donald Trump has made tariff threats, other than on the very first occasion. Each devaluation has grown progressively larger, with last week’s devaluation —in response to Donald Trump’s threat to impose 10% tariffs on an additional US$300 billion worth of Chinese goods — the largest. Originally set to take effect on 1 September, but since delayed to December, this would increase the total value of tariffed imports to US$550 billion, essentially all US imports from China.
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Allowing the renminbi to weaken is not without risks for China, exemplified by the mass capital outflows caused by the devaluation of the renminbi in 2015. It also risks fuelling global imbalances and intensifying criticism of China’s policies. Nonetheless, as shown below, Beijing has now unwound all of the renminbi appreciation which occurred in the year after Donald Trump’s election victory in November 2016, when a deal appeared to be on the cards, and over the past year the currency has, by and large, moved in line with our own expectations.
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Based on the offshore rate, the depreciation would be greater still were it not for the 2% trading band, defined by where the PBoC sets the mid-point as opposed to market forces. Indeed, the spread over the onshore rate has widened in recent weeks, as shown in the chart below. In the past, this spread has heralded further declines in the onshore value, which so far remains nowhere near weak enough to offset the US dollar price impact of Donald Trump’s tariffs in full. For that to happen, and assuming the latest tariff threat comes to pass, the USDCNY would need to fall to somewhere in the range of 7.6 to 8.7 — levels not seen since 2007.
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Having now breached the psychologically important threshold of 7.0, a depreciation of that ilk must be more likely. And although it is not our central scenario, if the economy continues to cool as we anticipate, then policymakers’ resolve is bound to be tested. A sharp depreciation would put downward pressure on global prices at a time when central banks are struggling to hit inflation targets. Our own view, as it has been for some time, is that renminbi depreciation has further to go, albeit steadily, as China’s policymakers tread carefully.
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