By Tom Westbrook and Alun John
SINGAPORE/LONDON (Reuters) – High-level discussions in China about allowing the country’s currency to weaken next year underline the risk to investors and companies that there will be big moves in exchange rates if U.S. tariffs hit global trade and money flows shift, analysts say.
Reuters reported on Wednesday that China is considering letting the yuan fall to weather a likely sharp rate hike, citing people familiar with the matter. The yuan immediately fell against the dollar, along with currencies across Asia that are highly sensitive to Chinese demand. [FRX/]
While the yuan was widely expected to weaken due to exchange rate pressure since the election of Donald Trump as US president, framing it as a policy shift could herald the start of a new round of global tariffs, trade tensions and currency intervention.
“Currency adjustments are on the table as an instrument to mitigate the effects of tariffs. I think that’s clear,” said Fred Neumann, chief Asia economist at HSBC in Hong Kong.
“Making the currency weaker could be a signal from China to the rest of the world that imposing tariffs has exchange rate implications.”
A cheaper exchange rate helps exporters by making their prices more competitive internationally.
The yuan fell about 0.3% to 7.2803 against the dollar after the Reuters report. The Australian dollar, which is sensitive to movements in the yuan given strong commodity exports, hit a one-year low.
Trump has said he plans to impose a 10% universal tariff on imports to the US and a 60% tariff on Chinese goods.
Financial markets have been preparing for more volatility since his inauguration on January 20, but are unsure how seriously to take his threats.
Reuters spoke to three people with knowledge of the discussions about allowing the yuan to weaken. One said the central bank had been considering a drop to around 7.5 per dollar – a depreciation of roughly 3.5% from current levels around 7.25.
Still, this is on the weaker side of investment bank expectations, adding to the feeling among investors that China is determined to be better prepared for trade shocks this time.
“If they need to revive the economy, and they are more interested in focusing on exports, then there is a compelling logic that they will allow the economy to soften,” said Jane Foley, head of currency strategy at Rabobank.
INTENSE, FAST
A complicating factor for China is that any decline would see the yuan disappear against non-dollar currencies, especially in Asia, where many neighboring countries such as Vietnam have grown as hubs for sourcing Chinese manufactured goods and avoiding US sanctions.
Rong Ren Goh, portfolio manager in the fixed income team at Eastspring Investments, said he expects China to achieve a controlled and gradual depreciation, but that “Asian currencies, especially those of export-driven economies, are likely to adjust along with the yuan. a trade-weighted basis.”
China’s exporters have been hoarding dollars with an eye on a 7.5 rate as a starting point for sales, but they have also been looking for ways to avoid currency risk altogether by invoicing in yuan and other similar solutions – especially now that the yuan has acquired this value. years on peers.
“If China aggressively depreciates the currency, it increases the risk of a tariff cascade,” HSBC’s Neumann said, if it prompts other economies to impose their own tariffs to protect their industrial bases from extremely cheap Chinese imports.
“It could lead to a backlash among other trading partners, and that is not in China’s interest.”
To be fair, much of the risk lies in the speed or shock value of any U.S. action, and some market participants do not expect Trump to be in a hurry to take immediate action.
“There are voices in the markets calling for a rapid depreciation of 10 to 20% (in the yuan) to help offset tariffs,” said Lynn Song, ING’s Greater China economist.
“We do not expect a deliberate and sharp depreciation like this as it will not be effective to counter tariffs as this could easily be categorized as currency manipulation by the US and could result in further tariff increases.”
Yet at recent analyst briefings in Singapore, Trump’s trade policy was seen as a wildcard and a weaker Chinese currency was the consensus among analysts at Nomura and MUFG.
“My view is that there will be currency flexibility,” Craig Chan, head of global currency strategy at Nomura, said before Reuters’ report on China’s forex discussions.
He advised some long dollar positions in Asia.
“Long dollar/CNH is one. We have a target of 7.60 by the end of May. It could be intense, it could be fast,” he said. “That would clearly be the risk for the dollar/China – to go higher and faster.”
And at MUFG, the forecast for a decline to 7.5 per dollar was based on the assumption of an average tariff of 40% on Chinese goods.
“A 60% tariff on Chinese products would require a 10% to 12% depreciation of the yuan against the dollar (since September) to 7.8 or higher… all else being equal,” MUFG said analysts.
During Trump’s first term as president, the yuan weakened more than 12% against the dollar during a series of tit-for-tat rate announcements between March 2018 and May 2020.
