So long as there are little signs of stress building into the system, there is little incentive for China to discourage FX weakness. After all, the nearly 10% USD/CNY move since March has almost completely offset the impact of Trump’s potential tariffs before they have even happened. Perhaps this is why the US President’s Twitter feed has turned back to talking down the dollar.
It doesn’t get much simpler than that when it comes to explaining how effective Beijing has been thus far in using the yuan to cushion the blow from the trade frictions.
It’s not entirely clear whether the Trump administration realized just how many policy levers the PBoC has at its disposal when it comes to micromanaging liquidity conditions and otherwise imparting an easing bias in a kind of under-the-radar fashion, the scope of which is only discernible after the fact.
China is countenancing yuan depreciation and while some of the measures taken in the course of that effort are headline worthy (RRR cuts, record MLF, etc.), others aren’t as overt. One way or another, they’re all reflected in the market and the cumulative effect has manifested itself in a rapid weakening of the currency, much to the chagrin of Donald Trump.
But while Trump does seem to appreciate the fact that rate differentials are what’s helping to push up the dollar against the yuan (and against the euro), he seems not-so-blissfully unaware of how adept and shrewd the PBoC has been about this.
It’s hard, for instance, to pin the PBoC down on anything. After all, M2 grew just 8% YoY in June, the slowest pace in more than two decades. And while the amount of new yuan loans extended continues to suggest authorities are having some measure of success in keeping credit flowing to the real economy, the effort to squeeze leverage out the shadow banking complex always risks inadvertently choking off that flow. Off-balance-sheet lending growth actually went negative in June, marking the first YoY contraction in recent history. So it’s not as though China doesn’t have a legitimate case for wanting to deemphasize deleveraging and implement some targeted easing measures.
In other words, Beijing can quite plausibly suggest that the trade frictions are adding to an already precarious situation wherein authorities are attempting to balance deleveraging with guarding against a “hard landing”.
So how do you distinguish between an “honest” effort on the part of monetary authorities in China to keep liquidity ample and prevent a “hard landing”, on one hand, and the facilitation of yuan weakness aimed directly at propping up exports on the other? You can’t. It’s impossible. And China knows it.
China also knows that the Fed is pot committed. Jerome Powell has to hike and even if he had some optionality before, that went out the window late last week when Donald Trump politicized interest rates. The Fed is behind the proverbial eight ball.
This is complicated even further (from Steve Mnuchin’s perspective anyway) by the fact that China can point to rate differentials as a “market-based” rationale for yuan depreciation. Of course they are actively facilitating the policy divergence, but as detailed above, it’s especially hard to pin them on that.
“CNY has been broadly led by China’s rate differential vs. the rest of the world even though the FX-rates linkage is less clear-cut in China given the authorities’ currency management”, Goldman writes, in a note dated Wednesday, before adding that “domestic rates have eased considerably even as global rates have edged higher, which has squeezed China’s rate differential to the lowest level since 2010.”
To what extent does the concurrent currency weakness cushion the blow from the trade frictions, you ask? Well, here’s Goldman to explain:
About one-third of CNY changes pass through to export prices, which in turn affect exporters’ market share gains/losses. Our estimate there similarly implies that a 10% depreciation in CNY TWI could lead to a 5pp increase in exports, or 70bp in GDP, with roughly 3 quarters’ lag. Therefore, based on these estimates, the roughly 6% CNY TWI fall since the mid-June peak should map to a 40-50bp support to GDP, which would essentially offset our estimated direct growth drag from the first two rounds of US tariff measures (the 25% additional duty on $34bn+$16bn and 10% on another $200bn of Chinese goods), although the boost would probably be realized in full a few months later.
Read that again. On Goldman’s math, the yuan’s fall since midway through last month has already offset not only the first round of tariffs on $50 billion in Chinese goods, but also the prospective second round of tariffs on an additional $200 billion in exports to the U.S.
They are months ahead of the game on this in two respects. First of all, tariffs have only gone into effect on $34 billion in Chinese goods. But they’ve already offset the second stage of the first round (duties on $16 billion in additional goods) and the second round (the prospective imposition of tariffs on another $200 billion in exports). Second, because there’s a lag here, they can effectively roll this effort back by strengthening the yuan in the event there’s some kind of resolution.
All of that without grabbing too many headlines. Sure, the PBoC eschewed OMO hikes following the Fed in June, a break with recent precedent. And yes, they squeezed in the RRR cut. Finally, we did see the largest MLF operation in history this week. None of that is exactly “below the radar” (so to speak) but with the exception of the RRR cut, all the various measures China has resorted to of late seem aimed at micromanaging near-term conditions with an eye towards a cumulatively large medium-term impact. That, as opposed to the kind of overt, slap-in-the-face, overnight bombshell that would leave the PBoC vulnerable to criticism.
When you throw in the new “proactive” approach to fiscal policy (tipped earlier this week), you end up with a scenario where China has not only negated the effect of the tariffs months in advance, but is now prepared to compliment that with fiscal stimulus.
As long as capital flight doesn’t pick up in China, it’s going to be extremely difficult for the Trump administration to figure out how to “win” this war. Amusingly, the understated manner in which Beijing has gone about all of this suggests that Trump likely doesn’t even understand what’s actually going on, his crude, surface-level FX shrieking notwithstanding.
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