In mid-May, U.S. President Donald Trump eased some restrictions on the Chinese technology giant, Huawei, and the United States and China agreed to call a ceasefire to their trade war and resume talks.
During the cease-fire, the Chinese yuan mostly traded between CNY 6.92 and 6.87 versus the U.S. dollar, which was a remarkably narrow and stable range given all that was happening in the world -- Fed rate cuts, turmoil in the crucial oil shipping lane along the Strait of Hormuz, Hong Kong protests, and more Brexit drama, etc.
Then, on August 1, as the U.S. trade negotiating team was traveling back to Washington from Shanghai, the U.S. President abruptly broke the ceasefire by threatening to impose 10 percent tariffs on $200 billion more of Chines imports into the U.S. -- including consumer goods and holiday toys. The Chinese responded on Monday, August 5, 2019, by devaluing the Chinese yuan through the invisible 7-line, taking the currency toward 7.10 to the U.S. dollar.
The case for an appreciating Chinese yuan always rested squarely on the question of whether optimism for a trade deal between the U.S. and China would emerge. A trade deal would usher in very positive growth expectations in the U.S. and China. The opposite has now happened.
The new tit-for-tat developments render the likelihood of any trade deal as extremely low. Indeed, the U.S. threat to impose more tariffs made during the middle of sensitive negotiations sends a strong message that the U.S. does not really want a deal. The U.S. position now seems to be to keep the pressure on China and see what happens to their economy down the road -- effectively postponing any deal until after the U.S. elections.
For Chinese President Xi Jinping, the most important point politically for him is not to be seen as being bullied by the U.S. So, taking a strong stance makes political sense. A devaluation also effectively negates the tariff threat, by making Chinese goods cheaper in U.S. dollar terms.
It will be interesting to see how far the Chinese currency depreciation goes. There was an invisible barrier at CNY 7 per U.S. dollar, a line that the Chinese government had previously not wanted to breach for fear of angering the U.S. and leading to even further tariffs increases. Since the tariffs are coming anyway, the Chinese authorities lost their incentive to defend the 7-line and are now using currency depreciation to offset any tariff impact.
Importantly for global markets, the U.S. tariffs now appear to be permanent. This is an extremely negative development for global trade and growth, which was reflected in the sharp downward movement in equities around the world as the trade tensions escalated -- possibly beyond the point of no return.
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(This article is sponsored and produced by CME Group, which is solely responsible for its content.)