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A currency war would be one-sided if US/China trade dispute escalates

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The big question that arises whenever trade wars emerge is the extent to which the principal actors involved devalue their domestic currencies. For the US and China, the battleground is substantially uneven in the sense that China basically controls all of the possibilities to manipulate its currency, whereas the US has limited measures to do likewise.

As FXCM has written, last July the People’s Bank of China set the reference rate for the Chinese renminbi to 6.7671 RMB against the US dollar. It led to an instant 0.9 per cent devaluation and led to the RMB spiking at 6.9348 by mid-August. 

“If there were a currency war, it would be an uneven one,” says Lukas Daalder (pictured), Chief Investment Strategist at BlackRock (Amsterdam). “Will there be such a battle or will we see it played out at a different level? For example, the Chinese authorities could make it much more difficult for US companies to get licenses and do business on the mainland.” 

Daalder will be speaking on a panel entitled “Are trade wars spiralling into a currency war?” at ABN AMRO Clearing’s hugely popular Amsterdam Investor Forum; a leading forum for institutional investors and alternative investment managers. The event is running 19 and 20 March, 2019.   

So far, the US has imposed tariffs on USD250 billion worth of Chinese goods, while China has retaliated by imposing duties on USD110 billion of US products.

The trade war with the US is contributing to further weaken the RMB and adding to the concerns among global investors that the world’s second largest economy could be heading for a further slowdown. 

The issues are complicated and while much is made of the trade dispute, a potential currency war is likely to also have its roots in China’s domestic economy, not purely in US trade tariffs. 

“Towards the end of 2018 there was a lot of concern over the state of the global economy,” says Daalder. “We had all the political uncertainties – Brexit, the US Government shutdown, US/China trade tariffs – and most macro data was falling off a cliff as well: Germany almost moved into recession, US production confidence dropped quite dramatically and there was a lot of concern over whether we’d arrived at the end of the expansion cycle and were possibly heading into recession.

“We’ve taken a close look and based on the research we’ve done we believe the global economy is slowing, but we don’t think there is going to be a recession. If there are no major shocks (i.e. a no-deal Brexit) and we avoid a trade war, the world economy could end up going through a phase of synchronised contraction (in 2017 we saw synchronised expansion) but it won’t be so bad that we move into recession.”

The World Bank is forecasting China’s GDP to slow to 6.2 per cent in 2019, down slightly on last year. Will this have any bearing on the trade war? Daalder thinks the opposite: that the trade war will influence China’s GDP growth.

“When we look at China we are slightly at odds with the World Bank,” explains Daalder. “We note that the Chinese authorities are going back to their old game of stimulating the economy, although admittedly in a different way to the past. Growth is now less credit-driven. The authorities are implementing tax cuts and developing new infrastructure projects that are helping to lower the reserve ratio.

“In Q1 2019, the GDP figures might not be that impressive but in Q2 and Q3 we expect to see various stimulus effects taking effect in the economy. So we are not that worried about China’s growth per se, although it is fair to say that the trade negotiations with the US are an important variable.”

On Christmas Eve, the volatility index (VIX), which some like to call the ‘fear and greed’ index, spiked above 36 while the Dow Jones Industrial Average crashed below 23,000 on 20th December: a 4,000 point decline from its October peak. 

Discussing the US economic outlook, and its repercussions for the US dollar, Daalder confirms that BlackRock’s base case is also one of a slowdown for 2019. Economic forecasts for US GDP growth are 2.3 per cent; down from 3 per cent in 2018.

Daalder says there are two key reasons for the expected contraction.

Firstly, the tax impact (after the administration cut corporate tax rates from 35 per cent to 21 per cent) will start to drop out of the figures, probably from Q2 onwards, and the bounce it gave the economy will likely wane. 

“Secondly, the willingness for US corporates to invest is falling short of what the government would have hoped. It was hoped cutting taxes would act as a catalyst for companies to invest in new activities. This has yet to come through in the numbers and closing the government hasn’t helped anyone. If the trade war with China escalates that would pose a third, additional risk to overall US GDP growth,” states Daalder. 

He thinks the risk to US 10-year Treasury yields widening out are somewhat limited, especially given the equity market volatility in December 2018. This has caused bond yields to fall from 3.2 per cent to 2.6 per cent.

“The risk to bond yields rising seems to be somewhat limited in my view. Much will depend on what happens with inflation and the US labour market. If inflation starts to pick up (and there is no sign of that happening yet), then bond yields will probably rise. Otherwise US Treasuries offer value at current yield levels,” says Daalder.

In conclusion, Daalder suggests that for Asian emerging markets, even if there is an escalation of the trade war, it is unlikely to have a serious knock-on effect on regional currencies; helped further by strong domestic demand. Also, unlike the Asian financial crisis in 1997, emerging market economies have a much lower debt burden and some countries, such as Taiwan, run a current account surplus.

“However, the Chinese economy is the main engine behind EM growth and if its economy slows down because of the trade war it will have a more pronounced knock-on effect and it could lead to a wider economic slowdown in Asian emerging markets. 

“It depends how this trade war develops. Let’s hope it doesn’t.”


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