Wall Street faces fur­ther tu­mult should China be la­beled a cur­rency ma­nip­u­la­tor

Business World - - Banking & Finance -

WALL STREET is brac­ing for the prospect that the US uses this month’s semi­an­nual for­eign-ex­change (FX) re­port to la­bel China a cur­rency ma­nip­u­la­tor, es­ca­lat­ing the trade stand­off be­tween the two na­tions at a time when ris­ing bond yields are al­ready dent­ing riskier as­sets.

The sce­nario is viewed as pos­si­ble — though not prob­a­ble — given the yuan has tum­bled more than 9% against the dol­lar over the past six months, rais­ing spec­u­la­tion that China has been de­lib­er­ately weak­en­ing the cur­rency. The US is con­cerned about the de­pre­ci­a­tion, and wants to make sure it’s not be­ing used as a com­pet­i­tive de­val­u­a­tion, Trea­sury Sec­re­tary Steven Mnuchin said in an in­ter­view in Bali Thurs­day. If the White House for­mally im­poses the des­ig­na­tion on China, that would be the first time since 1994.

Such a de­ci­sion would likely un­leash fresh tur­moil in global mar­kets just as a surge in Trea­sury yields has helped spur the big­gest sell­off in US stocks since Fe­bru­ary. The strife is com­pound­ing weak­ness in the yuan, with bets mount­ing that 7 per dol­lar is around the cor­ner, a level un­seen since the fi­nan­cial crisis. With trade re­la­tions be­tween Washington and Bei­jing sour­ing, in­vestors would be re­miss to ignore the risks, ac­cord­ing to Gold­man Sachs Group Inc.

“There’s a higher risk that the Trea­sury uses the re­port to re­flect its broader trade goals,” said Zach Pandl, co-head of global FX strat­egy at the New York-based bank. Such an out­come is not his base case, he said. “Mar­kets would in­ter­pret it as a fur­ther es­ca­la­tion of the bi­lat­eral trade dis­pute, and for the FX mar­ket, that has so far been in­ter­preted as a new source of down­side risk to global growth.”

Such a move by the Trea­sury would hit Aus­tralia’s dol­lar par­tic­u­larly hard, given the na­tion’s close ties to the Chi­nese econ­omy, ac­cord­ing to Pandl. The Aussie has slid more than 9% against the green­back in 2018, and is cur­rently trad­ing near its weak­est level since early 2016.

Gold­man is far from alone sound­ing the alarm. Ahead of the Trea­sury’s de­ci­sion, Cit­i­group Inc. rec­om­mends pro­tect­ing against fur­ther Aus­tralian-dol­lar weak­ness against the yen, which of­ten strength­ens amid acute mar­ket stress.

While China doesn’t meet the three of­fi­cial cri­te­ria the US cur­rently uses to judge whether a coun­try is a cur­rency ma­nip­u­la­tor, the Trea­sury could change the thresh­old, ac­cord­ing to Todd Elmer, Cit­i­group’s head of Group-of-10 for­eign-ex­change strat­egy for Europe, the Mid­dle East and Africa. In Au­gust, Pres­i­dent Don­ald Trump said the US was study­ing its cur­rency ma­nip­u­la­tion formula.

“There is prob­a­bly a 50-50 chance that the US will go so far as to out­right name China a ‘ma­nip­u­la­tor’,” Elmer wrote in a re­port Wed­nes­day. “There is noth­ing to stop of­fi­cials from ei­ther re­vert­ing to ear­lier cri­te­ria, which pro­vide room for more dis­cre­tion, or in­tro­duc­ing new lan­guage en­tirely.”

A for­mal des­ig­na­tion car­ries no im­me­di­ate con­se­quences, but the ad­min­is­tra­tion may use the la­bel as jus­ti­fi­ca­tion for a fresh round of tar­iffs, Elmer wrote.

The on­shore yuan fell 0.10% to 6.9310 per dol­lar as of 1:38 p.m. in Shanghai, close to its Au­gust low, which was the weak­est level since Jan­uary 2017. The off­shore yuan was down 0.22% at 6.9394.

OB­VI­OUS TOOL

A Trea­sury spokesper­son didn’t im­me­di­ately re­spond to re­quests for com­ment.

The im­pact of such a des­ig­na­tion could reach be­yond mar­kets as well. Given China’s rel­a­tively mod­est cur­rent-ac­count sur­plus and lack of in­ter­ven­tion in FX mar­kets, there is no ba­sis to name the coun­try a ma­nip­u­la­tor, ac­cord­ing to for­mer US Trea­sury of­fi­cial Mark So­bel. Do­ing so could fur­ther sour on­go­ing US-China ne­go­ti­a­tions, he cau­tioned.

“Lack­ing merit, it would un­der­mine the long­stand­ing in­tegrity and rigor of the FX re­port,” said So­bel, US chair­man of the Of­fi­cial Mone­tary and Fi­nan­cial In­sti­tu­tions Fo­rum. “Fur­ther­more, it could very well com­pli­cate Sec­re­tary Mnuchin’s wel­come and laud­able ef­forts to main­tain a dia­log with se­nior Chi­nese lead­er­ship.”

While the Trea­sury has re­frained from la­bel­ing the Asian na­tion a ma­nip­u­la­tor three times un­der Trump, the US-China trade re­la­tion­ship has de­te­ri­o­rated since the re­port’s last re­lease in April. The US im­posed tar­iffs of 10% on $200 bil­lion of Chi­nese goods last month, with a prom­ise to in­crease the levy near year-end. Bei­jing re­tal­i­ated, im­pos­ing du­ties on $60 bil­lion of US im­ports.

“Ten­sions be­tween the US and China have gone up and you’ve seen Trump uti­lize other av­enues in this on­go­ing es­ca­la­tion, so I think the use of this as a tool seems ob­vi­ous,” said Daniel Hui, an an­a­lyst at JPMor­gan Chase & Co. “Given where we are now in this re­la­tion­ship, I don’t think it’s con­tro­ver­sial to say there’s a higher prob­a­bil­ity that he’ll take this step, this time.”

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