USD/CNY: Trade War Turned into a Currency War and Escalates the Relationships Between the US and China

The US-China trade war has turned into a currency war. The latest manufacturing numbers released by China’s National Bureau of Statistics yesterday show the first hard evidence that US President Donald Trump has weakened Chinese President Xi Jinping’s hand in the nine-month-long trade war between the two economic superpowers. In the face of escalating US tariffs against Chinese goods, Chinese factory orders have declined after 15 months of expansion.
FX Empire Editorial Board

The news should excite currency traders who have sought to profit from increased volatility in the normally stable yuan this year. As a currency based on a fixed exchange rate controlled by the steady hand of the Chinese central bank, the Yuan has not heretofore received a lot of attention from traders. But traders should be aware that China has drawn a currency weapon to help prop up the Yuan.

The USD/CNY fell slightly to 6.8688 in early morning European trading but is still stable. The small bounce up seemed like a tepid response to evidence the US trade tactics are taking a toll on China’s manufacturing sector. But traders should take into account a heavier government price setting hand when estimating Yuan price moves.

In September, the South China Morning Post reported that the People’s Bank of China (PBOC) has reintroduced the ‘counter-cyclical factor mechanism’—described as a ‘black box’ used by market makers when setting the Yuan fixed exchange rate to protect against depreciation. Typically, the fixed rate is determined based on the previous day’s close and overnight changes in the basket of currencies the Yuan tracks. This rate is allowed to fluctuate up to 2 percent in the forex markets. Just before the trade war began in January, as the Yuan stabilized, China had withdrawn the mechanism but as the trade war puts downward pressure on the Yuan, the PBOC has decided to reinstate it.

For many market observers, such Chinese government interference to prop up its currency has turned the trade war into a currency war. For traders, trading on the news alone without taking the additional fixing mechanism into account could lead to overestimations of price movements in the Yuan.

Though when the US markets open, a more enthusiastic response to the decline in Chinese exports and manufacturing in the ongoing trade wars is expected. After 15 months of expansion and eight months after President Donald Trump started imposing tariffs on Chinese goods, China’s factory orders have slowed. The Purchasing Managers’ Index (PMI) for September declined to 50.8 from 51.3 in August. Officially, the 50-mark would indicate a contraction. Growth in new export orders, meanwhile, declined for the fourth consecutive month to 48.0 from 49.4 in August. Companies attribute the slowdown in exports to the US trade tariffs, according to the Caixin/Markit Manufacturing Purchasing Managers’ Index (PMI), which reported a similar decline in September orders.

The currency war is now expected to escalate the trade war. President Trump has threatened China with more tariffs if it engaged in manipulation of the Yuan. In July and August, the USD was strengthening against the Yuan, which no doubt triggered China’s decision to reintroduce the counter-cyclical mechanism. Additionally, China is lowering taxes and fees to increase business competitiveness. The Services sector performed better, increasing from 54 to 54.9.

Manufacturing accounts for 30 percent and the services sector 54 percent of the Chinese economy.

Thusly, the trade war is expected to continue to escalate and create volatility in the USD/CNY pair. The Yuan has become more sensitive to the trade war than the USD; most recently, rallying on rumors of new trade talks on September 13th and falling three days later on Trump’s announcement of intentions to impose 10 percent tariffs on another $200 billion in goods by the end of September, and that tariff is set to rise to 25 percent by the end of the year. Furthermore, if China retaliated, which it did with tariffs in $60 billion on US goods, the US has threatened tariffs on an additional $287 billion in Chinese goods.

 USD/CNY implied one-day volatility of 4.9527 is steadily declining to 4.5600 for two-month volatility, and then slowly but steadily rising over the next three years.[1] Could the year-end volatility rise coincide with President Trump’s next trade salvo? Other factors will make the Yuan a more interesting volatility play going forward. Notably, to further ease pressure on the Yuan from the trade wars, China is accelerating the opening up of its capital markets and efforts to allow full convertibility of the renminbi. The Yuan trades offshore as the Offshore Renminbi (CNH).

Don't miss a thing!
Discover what's moving the markets. Sign up for a daily update delivered to your inbox

Latest Articles

See All

Expand Your Knowledge

See All
The content provided on the website includes general news and publications, our personal analysis and opinions, and contents provided by third parties, which are intended for educational and research purposes only. It does not constitute, and should not be read as, any recommendation or advice to take any action whatsoever, including to make any investment or buy any product. When making any financial decision, you should perform your own due diligence checks, apply your own discretion and consult your competent advisors. The content of the website is not personally directed to you, and we does not take into account your financial situation or needs.The information contained in this website is not necessarily provided in real-time nor is it necessarily accurate. Prices provided herein may be provided by market makers and not by exchanges.Any trading or other financial decision you make shall be at your full responsibility, and you must not rely on any information provided through the website. FX Empire does not provide any warranty regarding any of the information contained in the website, and shall bear no responsibility for any trading losses you might incur as a result of using any information contained in the website.The website may include advertisements and other promotional contents, and FX Empire may receive compensation from third parties in connection with the content. FX Empire does not endorse any third party or recommends using any third party's services, and does not assume responsibility for your use of any such third party's website or services.FX Empire and its employees, officers, subsidiaries and associates, are not liable nor shall they be held liable for any loss or damage resulting from your use of the website or reliance on the information provided on this website.
This website includes information about cryptocurrencies, contracts for difference (CFDs) and other financial instruments, and about brokers, exchanges and other entities trading in such instruments. Both cryptocurrencies and CFDs are complex instruments and come with a high risk of losing money. You should carefully consider whether you understand how these instruments work and whether you can afford to take the high risk of losing your money.FX Empire encourages you to perform your own research before making any investment decision, and to avoid investing in any financial instrument which you do not fully understand how it works and what are the risks involved.