Wall Street is bracing for the prospect that the U.S. uses this month’s semiannual foreign-exchange 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 percent against the dollar over the past six months, raising speculation that China has been deliberately weakening the currency. The U.S. 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 U.S. 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 percent 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 U.S. 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 U.S. was studying its currency manipulation formula.
“There is probably a 50-50 chance that the U.S. 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 percent 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 percent at 6.9394.