The Obama administration is navigating a thin stretch of waters right now and may find itself in cornered by two counter-acting forces: Chinese unwillingness to appreciate the Renminbi and the populist tendencies of Congress due to upcoming elections. The risk that China underestimates the populist tendencies of the US representatives ahead of the November mid-term elections is far from understood by the market.
After the initial 1% move in the USDCNY on June 21 following the announcement to allow the Renminbi to resume appreciation, Beijing frustratingly went on to fix the Renminbi weaker against the USD through July and August, having escaped being labelled a currency manipulator in the US Treasury currency report in July.
The pace of appreciation has accelerated again in the last 10 trading sessions. The Renminbi appreciation tends to accelerate ahead of key events but fails to sustain the pace thereafter. More of such maneuvering is likely from China going forward. It remains to be seen if this time aroudn the pace of appreciation can be sustained.
About the Omnibus Trade and Competitiveness Act of 1988
The Omnibus Trade and Competitiveness Act of 1988 was targeted at achieving better coordination of macroeconomic policies of major industrialized nations with appropriate levels of trade and current account balances between these nations. The Treasury Secretary shall analyze the exchange policies of the US’ trading partners and determine if these countries are gaining unfair competitive advantages in trade which “prevents effective balance of payment adjustments”.
If found guilty, the House could impose severe tariffs on Chinese imports as it did in 1971 when it imposed a 10% surcharge on imports from major exporting countries after negotiations for FX adjustments were ignored. This was removed a few months later after Germany, Japan and other large exporting nations allowed their currencies to appreciate against the US dollar.
While we do not think such a decision would be taken lightly in an environment of fragile global economic health – indeed our base case is for the Treasury to avoid labeling China a manipulator – the risk of such a move may be higher now given the looming US mid-term elections amid a moribund US economy.
Where to allocate given these risks?
Such a move would clearly deal a major blow on global trade, potentially leading to a sell-off of the USD and Asian currencies for other safe haven currencies such as the CHF, KRW , SEK. Even the EUR could in this case be seen as a safer haven than the USD as the risks of policy retaliation heighten. Most Export oriented EM currencies that depend on China’s exports would take a major hit as trade activities are likely to plunge.
UDN - PowerShares DB U.S. Dollar Bearish
FXF - Swiss Franc CurrencyShares
FXS - Swedish Krona CurrencyShares
Disclosure: No positions