The Chinese yuan plummeted 3%--its lowest this year, hitting a six-month low against the dollar (USD). During the session, the yuan was down more 0.5% to against the USD for the third straight day in a row. There hasn’t been a drop this dramatic since China’s August 2015 devaluation where the currency fell 2.8% in just two days.
The fall is post a period where its growth was strongest. This move is in concurrence with an increase in trade tensions with the United States, igniting concerns that China might engage in devaluation as a policy tool. It should be noted that China’s currency is not fully floating as it is managed, this previously sparked comments on the country being a currency manipulator. This sharp movement in the currency signals that Beijing wants a weaker currency while the cloud of a trade war persists. Please note that a 10% depreciation can counter the Trump tariffs at a 10% rate.
Additionally, China’s state-run newspaper wrote that the nation should engage in “self-defense measures” against the Trump tariffs. Correspondingly, the People’s Bank of China (PBOC) increased its' activity and set a midpoint for the USD/CNY’s trading range at 6.5669, the highest level since Dec. 25 2017. This increase in the U.S. dollar/Chinese yuan (USD/CNH) currency pair indicates the dollar is strengthening against the yuan. The drop in the yuan caught many traders by surprise, leading to a precipitous drop in the Austrailian and New Zealand dollars. The yuan's fall also served to boost the Japanese yen as risk aversion begins to lift.
As a counter position, signs of stability are evident in the gap between one-month and 12-month non-deliverable yuan forwards. This seems to indicate that traders do not expect yuan depreciation to persist in the long term and there are manifold reasons for Beijing not to continue a weakening policy in the long term. The bulk of China's efforts in having the yuan added to the basket of SPDR's and other inclusive acts are to present the currency as a viable currency in commerce. This strategy also carries significant risk as it could provoke capital outflows.
However, in the immediate term it is unlikely Xi or President Trump will back down from their respective positions as trade tensions continue to escalate. These tensions and the subsequent positioning will continue to affect the foreign exchange market.
Expect the renminbi to continue to weaken in the near term, with USD-CNY continuing to trend higher.
Image: Shawn Baldwin with Justin Zhang, General Manager of the China Foreign ExchangeTraded System (CFETS).