The latest shots in the US-China trade dispute show the need for rational policy coordination in the US. Last night, the US Treasury labelled China a Currency Manipulator, a designation which opens the door to punitive actions. The basis for this decision was a devaluation of the Renminbi and breach of the 7 level against the US Dollar. The People's Bank of China had defended this key technical level since early 2008, which has resulted in the characterisation of the breach as a weaponisation of the currency to benefit Chinese exports. The US Treasury rationale for the label was that the PBOC has sufficient currency reserves—which it can sell in order to purchase its own currency—to defend the level, but has chosen not to do so. This is somewhat ironic since it would require active intervention by the PBOC to strengthen the currency, while it has simply allowed the market to drive the currency lower. At this stage in the dispute, the Currency Manipulator label is mostly a symbolic gesture since China already faces quite a raft of additional tariff charges on September 1st. The more important implication of the escalation in tensions is that it undermines business confidence and harms the global growth outlook.
In recent weeks, Trump has become more antagonistic in his Fed criticism; his preference would be dramatic monetary easing which would support the US economy, particularly when heading into a full-scale trade war. Unfortunately, the Fed’s last decision—reducing rates due to deteriorating global business sentiment rather than domestic factors—has opened the door to manipulation of the Fed's mandate by the administration. The Trump administration can truly ramp up the trade battle and know that the Fed will react to the worsening global environment, now the precedent has been set.
Bottom line: In the latest weekly update, we argued that a reduction in rates isn’t nearly as stimulative as the market seems to believe, which means this strong-arm tactic may work until the Federal Reserve Board decides the additional benefit is not worthwhile. The ambivalent statement from Jerome Powell during the last press conference—it’s a ‘mid-cycle adjustment’ not the start of an easing cycle, but it might be more than one cut, maybe—suggests the efficacy of further loosening at this stage is already in question. The end result may be a dramatically out of sync fiscal/monetary policy framework: declining investment but monetary policy shifting to neutral. In that environment, a lack of policy coordination in the US makes it more susceptible to shocks, than the centrally-planned Chinese economy.
So far this year, the RBA has implemented back-to-back interest rate cuts while households have benefited from income tax cuts to support a deteriorating economy. Overnight, the RBA decided to keep rates on hold in order to assess the impact of recent stimulus on the Australian economy. RBA Chief Philip Lowe stated 'an extended period of low interest rates will be required in Australia to make progress in reducing unemployment and achieve more assured progress towards the inflation target'. Since China accounts for a third of Australian exports, it’s no wonder that a slowdown in the Chinese economy and an escalating trade war has disrupted Australian economic growth. The tumult has caused a depreciation of the Aussie Dollar to the weakest level in a decade. Escalation of the US-China trade war will not be welcome news to the RBA which is already battling domestic economic issues and might find policymakers cutting rates towards the zero lower bound in due course.
Bottom line: Improving government deficits may provide an opportunity for fiscal policy action—a privilege that many developed economies do not have, but desperately need.
The Pound was subdued in trading yesterday over growing concerns of either a general election or a no-deal Brexit. Cable may have traded flat since the recent sharp decline, but its failure to produce any meaningful recovery signals a continuance of near-term bearish pressure.
Yesterday, Sterling hit a 23-month low against the common currency, during a day of sustained Euro strength. The 100-day moving average for the pair is close to crossing the 200-day in a clear sign of extended negativity. The Euro has now posted a 1.8% recovery since the lows of July 25th and sits comfortably in the middle of its 2019 trading range.
The pair has lost a little of its momentum from yesterday's rally as China set its Yuan fixing at a stronger-than-expected level. Still, some Dollar selling is in evidence this morning as the trade-weighted Index for the Greenback continues its downward trajectory. Price action will remain reliant on the intensifying US-China trade war that threatens to morph into a currency war.
All content is written by the Global Reach Trading Desk. The opinions expressed are not the view of Global Reach Group and are not intended as investment advice.