I am happy with the conclusion from my pre-holiday missive that FX volatility is making a comeback. The decision by the Treasury, i.e., the White House, to label China as a “currency manipulator” finally prompted the PBoC to step back and allow USDCNY to breach 7.0, forcing markets to consider the prospect of the trade wars morphing into a currency war. This is significant for two reasons. First, it confirms what most punters already knew; namely that the CNY is inclined to go lower if left alone by the PBoC. Secondly, the opening shots of a currency war have brought us one step closer to the revelation of far Mr. Trump is willing to go on this matter.
The problem for the U.S. president is simple. He can bully his main trading partners with tariffs, “winning” the trade wars, but he is losing the currency wars in so far as goes as his desire for a weaker dollar. The veiled threat to print dollars and buy RMB assets, as part of the move to identify China as a manipulator, is a loose threat. Just to make it clear; it would involve the Fed printing dollars and buying Chinese government debt and/or stakes in SOEs, which would probably be politically contentious. Moreover, the PBoC could respond in kind; in fact, it probably would.
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