It would be unwise to assume that today’s retaliation by China is the last tit for tat in the U.S.-China war.
What “reasonable” fears are making rounds today?
That the Chinese decision to let the yuan break the 7-yuan-to-the-dollar barrier isn’t the end of the slide in the Chinese currency. I’m hearing predictions of 7.20 yuan to the dollar for this fall and a drop to 7.40 yuan to the dollar by the end of the year. A drop to 740 yuan to the dollar would be enough to completely cancel out the latest 10% tariffs on an additional $300 billion in Chinese exports to the United States.
Which means, a number of pundits are saying today (and I have to agree with this scenario) that the Trump administration won’t stand pat on its latest round of tariffs. When President Donald Trump announced that later round of tariffs, he noted that the 10% initial rate could easily become 25% to match earlier tariff moves. That seems likely to me.
President Trump has already called on the Federal Reserve to do “something” to weaken the dollar. The bond market has concluded that this “something” will include an acceleration of the interest rate cuts coming in 2019. As of today the Fed Funds Futures market is pricing in not just two or three 25 basis point cuts but four as of December 11 Fed meeting. I doubt even that number of cuts would have the desired effect of weakening the dollar. The dollar is a relatively safe haven currency and the turmoil of this trade war guarantees strong buying of the dollar even as U.S. interest rates fall. The Fed has a very limited ability to manage the dollar lower under current conditions of negative interest rates in Europe and Japan, decent economic growth in the United States, and an already announced high level of deficit spending (which means that piece of bad news is already know by bond buyers.)
China’s political leaders are headed off for their annual summer retreat. President Xi Jinping will be under considerable pressure at that meeting to do even more to strike back at the United States. The financial markets will be lucky if all the emerges from that meeting is heightened rhetoric about how in this fight with the United States the Chinese people should drawn the spirit of the Long March that was crucial to the survival–and eventual victory–of the Communist Party.
And finally, a worry that I’ve only started hear from some voices on Wall Street. There’s a basis faith that the People’s Bank will be able to navigate an orderly retreat in the yuan to 7.40 to the dollar. That’s not a given, this worry goes. If nothing else, a decline of that magnitude in the yuan over such a short period of time is likely to re-ignite past problems of capital flight from China. The government was only able to get capital flight under control with great difficulty. It’s unlikely to be easier this time around.