Macro Monthly Market update – why did the Yuan slide past 7?

USD/Yuan at 7 was the symbolic line in the sand. Will China allow the Yuan to depreciate further? The market update also touches on US-China trade news.

08 Aug 2019

Market update summary

  • The most recent step-up in trade tensions heightens the risk of a non-linear escalation and we remain cautious on global equities.
  • That said, we are not concerned about China's authorities allowing the yuan to depreciate past 7, nor the US's largely symbolic decision to label China a currency manipulator.
  • At this point, the state of trade talks can improve just as quickly as it can deteriorate. We expect markets to remain volatile through the rest of the summer.
  • We are of the view there should be more risk premium reflected in the US dollar, given the change in US foreign exchange policy and intervention risks.

Subscribe now
Perspectives matter. Tune in to our insights.

We bring you 7 questions to understand the latest market updates.

1. Why did the Yuan slide past 7?

The 7 level in USD/CNY was viewed as a symbolic line in the sand. The onshore exchange rate had not traded beyond 7 since March 2008 and Chinese authorities have generally guided the market not to breach that level.

Following President Trump's latest tariff threat, Chinese authorities allowed the currency to surpass 7, sparking concerns that they would permit a sharper depreciation catalyzing broad FX weakness (and USD strength) that would lead to a sharp tightening of financial conditions for the US and emerging markets.

However, we believe that China’s decision to not set the CNY ‘fix’ weaker than market expectations in the following Asia morning signals that authorities are not looking to use the currency as an active weapon going forward, at least not at this point.

There are costs to currency weakening

  • Disrupt financial stability due to local outflows
  • China does not want to send a message of currency instability as it prioritizes opening up its markets
  • A sharp CNY deprecation would make goods more expensive for Chinese consumers.

For these reasons we see China’s recent allowance of a weaker currency as a warning shot to the US administration, as opposed to the start of a devaluation campaign.

On the day China allowed USD/CNY to slide past 7, Treasury Secretary Mnuchin officially labeled China as a currency manipulator (the first time Treasury had taken that step in 25 years). The timing of this move is somewhat ironic in that China had for months and years been taking steps to prevent its currency from weakening and the move beyond 7 was actually in line with market forces after the tariff threat.

While the Treasury Department’s step was unexpected and unlikely to be taken well by Chinese authorities, it is more symbolic than anything. The Treasury Department will engage in dialogue with the IMF and China over an entire year on steps that should be taken to alleviate trade imbalances. After that year, the President has some authority to impose penalties on China, but the scale of current and proposed tariffs on Chinese imports make those actions look minor in comparison.

The Treasury's currency manipulation announcement is just part of a broader evolution in US dollar policy under the Trump administration.

The President has verbally criticized China and Europe for competitive devaluations, demanded commitments not to devalue in trade agreements, and recently tasked aides to find ways to weaken the dollar.

This is a meaningful departure from the implicit strong dollar policy or at least a laissez faire one that has governed US FX policy for 25 years. The executive branch, via the Treasury Department, owns the right to intervene in foreign exchange markets. It is possible, especially in reaction to further dollar strength, that the President could authorize intervention to sell dollars against the offshore yuan, euro and yen.

If the Fed were to act in concert with the Treasury, as it has done historically, the Treasury could sell about USD200 bn into foreign currency. Such a move would shift the dollar lower in a knee-jerk fashion, and the signal has the potential to carry a more pronounced depreciation.

The Fed shifted to an easing stance in May, largely due to growing downside risks associated with slower global growth and trade tensions (along with persistently low inflation). These risks were magnified when the President delivered his tweet, just one day after the Fed had cut rates for the first time since 2008.

The President continues to demand easier Fed policy and is likely to get it especially after the tightening in financial conditions that followed the most recent uptick in trade tensions.

We suspect the Fed will ease by an additional 50 bps by year end. However, the bet that Fed easing will continue to offset growing economic and financial market damage is a risky one.

Fed easing impacts the economy with long and variable lags, while trade risks are a here and now for companies and consumers.

Markets are likely to remain volatile for the rest of the summer and conditions can improve just as quickly as they can deteriorate.

In the very near term, we are focused on whether the US Commerce Department issues some partial waivers to permit American companies to continue shipping products to China's Huawei.

This was part of the original deal out of the G20 in Japan, along with China agreeing to step up purchases of US agricultural goods.

Such a move (and ensuing agricultural purchase) would significantly de-escalate tensions and probably lead President Trump to scrap the plan to increase tariffs on September 1st.

Of course, the imposition of tariffs in September would be negative for global growth, risk assets and the path forward for US-China relations.

In our view the severity of the market reaction has less to do with the direct economic effects of a possible 10% tariff on the remaining USD 300 bn in Chinese imports, which is likely to take a few tenths off of US, China and global GDP.

Rather, we believe that markets are disturbed by the risk of non-linear outcomes of further escalation in both trade and technology. From the US side this includes a full 25% tariff on all Chinese imports (which could potentially be the last straw for a vulnerable global economy) or restricting sales of semiconductors to a wide range of Chinese companies. From China’s side, limitations on the sale of rare earths to US companies or prevention of particular US companies to operate or sell in China (known as the unreliable entities list) would also create significant disruption.

All of these next potential moves risk major disruption to the trade and technology relationships of the world’s two largest economies, with ripples across global supply chains.

The severity of the next moves in the trade war rings of ‘mutually assured destruction.’

In other words, any of the above steps would probably inflict meaningful pain not just on the receiving party but on the acting party itself. As such we view such escalations as unlikely, while acknowledging that markets must place some risk premium that they do happen.

Domestic political pressures not to back down are present on both sides, as are risks of miscalculation.

Our base case is that cooler minds prevail—now that the stakes have risen so high, the economic and political costs of further escalation on both sides are significantly larger than the benefits.

We moved neutral equities in May and in some portfolios went underweight after the July G20.

Our view was that a lot of good news was in the price, leaving markets vulnerable to negative surprises on growth, central bank action or trade tensions.

We maintain a cautious stance, given that meaningful uncertainties remain in the near term. That said, we do think developed market consumers are fundamentally in good shape and do not anticipate a recession over coming months.

With that backdrop, expectations for Fed easing have become a bit too aggressive and we have an underweight stance on duration over the next 12 months.

In currencies, we remain underweight the dollar which we think should have greater risk premium attached to it given intervention risks.

More insights

Singapore Retail Investors

PLEASE READ THESE TERMS AND CONDITIONS CAREFULLY BEFORE PROCEEDING. BY UTILIZING THE WEBSITE AND PAGES THEREOF LOCATED AT WWW.UBS.COM/AM-SG ("WEBSITE"), YOU ACKNOWLEDGE THAT YOU HAVE READ THESE TERMS AS WELL AS THE GLOBAL TERMS OF USE (collectively "TERMS") AND THAT YOU AGREE TO BE BOUND BY THEM. IF YOU DO NOT AGREE TO ALL OF THE TERMS OF THIS AGREEMENT, YOU ARE NOT AN AUTHORIZED USER OF THESE SERVICES AND YOU SHOULD NOT USE THIS WEBSITE.

THIS WEBSITE IS NOT INTENDED FOR AND SHOULD NOT BE ACCESSED BY PERSONS LOCATED OR RESIDENT IN ANY JURISDICTION WHERE (BY REASON OF THAT PERSON'S NATIONALITY, DOMICILE, RESIDENCE OR OTHERWISE) THE PUBLICATION OR AVAILABILITY OF THIS WEBSITE IS PROHIBITED OR CONTRARY TO LOCAL LAW OR REGULATION OR WOULD SUBJECT ANY UBS ENTITY TO ANY REGISTRATION OR LICENSING REQUIREMENTS IN SUCH JURISDICTIONS.  IT IS YOUR RESPONSIBILITY TO BE AWARE OF, TO OBTAIN ALL RELEVANT REGULATORY APPROVALS, LICENCES, VERIFICATIONS AND/OR REGISTRATIONS UNDER, AND TO OBSERVE ALL APPLICABLE LAWS AND REGULATIONS OF ANY RELEVANT JURISDICTION IN CONNECTION WITH YOUR ENTRANCE TO THIS WEBSITE. EACH INVESTMENT PRODUCT AND SERVICE REFERRED TO ON THIS WEBSITE IS INTENDED TO BE MADE AVAILABLE ONLY TO RESIDENTS IN SINGAPORE.

UBS RESERVES THE RIGHT TO CHANGE, MODIFY, ADD OR REMOVE CONTENT ON THE WEBSITE AS WELL AS THESE TERMS AT ANY TIME FOR ANY REASON WITHOUT NOTICE. SUCH CHANGES SHALL BE EFFECTIVE IMMEDIATELY UPON POSTING. YOU ACKNOWLEDGE THAT BY ACCESSING OUR WEBSITE AFTER WE HAVE POSTED CHANGES TO THESE TERMS, YOU ARE AGREEING TO THESE TERMS AS MODIFIED.

The materials on this Website are distributed by UBS Asset Management (Singapore) Ltd (company registration number: 199308367C), which is licensed by Monetary Authority of Singapore ("MAS") in Singapore pursuant to the Securities and Futures Act (Chapter 289).  UBS Asset Management (Singapore) Ltd is part of the Asset Management business division of UBS Group AG. UBS Asset Management (Singapore) Ltd together with UBS Group AG and its group companies shall collectively be referred to as "UBS".

The information contained in this Website has been prepared and is intended for general circulation. The information does not constitute advice and does not take into account the specific investment objectives, financial situation, or particular needs of any particular person. The investment services or products referred to in this Website may not be suitable for all investors. UBS recommends that you independently evaluate particular investments and strategies and seek independent advice from a financial adviser regarding the suitability of such investment products, taking into account your specific investment objectives, financial situation and particular needs, before making a commitment to purchase any investment products. Investment involves risks. You should be aware that investments may increase or decrease in value and that past performance is not indicative of future performance.

The information contained in this Website is not an offer to buy or sell or the solicitation of an offer to buy or sell any investment product or to participate in any particular trading strategy.

UBS, its officers and/or employees may have interests in any of the investment products referred to on this Website by acting in various roles. UBS, its officers and/or employees may receive fees, commissions or other benefits for acting in those capacities. In addition, UBS, its officers and/or employees may buy or sell investment products as principal or agent and may effect transactions which are not consistent with the information set out in this Website.

You fully understand and agree that, by making available this Website, UBS should not be construed as making: (a) any endorsement of any investment product referred to in this Website; (b) any representation that UBS has performed any due diligence on any investment product referred to in this Website; or (c) any representation that the information in this Website is complete, accurate, clear, fair and not misleading. The use or reliance on any such information contained in this Website is at your own risk and any losses which may be suffered as a result of you entering into any investment are for your account and UBS shall not be liable for any losses arising from or incurred by you in connection therewith. UBS is not responsible or liable for the accuracy and completeness of any such information or the performance or outcome of any investment made by you after receipt of such information, irrespective of whether such information was provided at your request.

Using, copying, redistributing or republishing any part of this Website without prior written permission from UBS is prohibited. Any statements made regarding investment performance objectives, risk and/or return targets shall not constitute a representation or warranty that such objectives or expectations will be achieved or risks are fully disclosed. The information and opinions contained in this Website is based upon information obtained from sources believed to be reliable and in good faith but no responsibility is accepted for any misrepresentation, errors or omissions. All such information and opinions are subject to change without notice. A number of comments in this Website are based on current expectations and are considered “forward-looking statements”. Actual future results may prove to be different from expectations and any unforeseen risk or event may arise in the future. The opinions expressed are a reflection of UBS’s judgment at the time this document is compiled and any obligation to update or alter forward-looking statements as a result of new information, future events, or otherwise is disclaimed.

UBS does not hold out any of its officers and/or employees as having any authority to advise you, and UBS does not purport to advise you on any investment product. Any investment will be made at your sole risk and UBS is not and shall not, in any manner, be liable or responsible for the consequences of any investment.

This Website and its contents are provided on an “as is” and “as available” basis. UBS does not warrant: (a) the accuracy, timeliness, adequacy commercial value or completeness of this Website or its contents, and expressly disclaims any liability for errors, delays or omissions in the contents, or for any action taken in reliance on the contents; (b) that your use of and/or access to this Website or its contents, will be uninterrupted, timely, secure or free from errors or that any identified defect will be corrected; (c) that this Website or any content will meet your requirements or are free from any virus or other malicious, destructive or corrupting code, agent, program or macros; (d) that any information, instructions or communications posted or transmitted by you through this Website is secure and cannot be accessed by unauthorised third parties; and (e) that use of the contents in this Website by you will not infringe the rights of any third parties. No warranty of any kind, implied, express or statutory, including but not limited to the warranties of non-infringement of third party rights, title, merchantability, satisfactory quality or fitness for a particular purpose and freedom from computer virus or other malicious, destructive or corrupting code, agent, program or macros, is given in conjunction with this Website.

You hereby agree to indemnify UBS and any of its officers, employees or agents against, and to keep UBS and any of its officers, employees or agents harmless from, any claims (actual and threatened), settlement sums, liability, loss, damages, costs (including solicitor and client costs and expenses (legal or otherwise)), charges, expenses, actions, proceedings, whether foreseeable or not which we may sustain, suffer or incur, directly or indirectly out of or in the course of or in connection with any the following: (a) any use of this Website or the contents by you, or any part thereof; (b) UBS having made available the Website; (c) any breach of these Terms by you, however arising; or (d) any negligence, act or omission, wilful default, unlawful act, fraud and/or misconduct on your part or violation of any rights of another person or entity by you.

The funds referred to in this Website have been authorised or recognised by the MAS for sale to the public in Singapore (the “Funds”). Copies of the registered Singapore prospectuses ("Prospectuses") referred to in this Website have been lodged with and registered by the MAS. The MAS assumes no responsibility for the contents of the Prospectuses. The registration of the Prospectuses by the MAS does not imply that the SFA or any other legal or regulatory requirements have been complied with.

MAS registration is not a recommendation or endorsement of a Fund nor does it guarantee the commercial merits or performance of such Fund. It does not mean that a Fund is suitable for all investors nor is it an endorsement of its suitability for any particular investor or class of investors. UBS Asset Management (Singapore) Ltd has been appointed as the representative for the Funds in Singapore for the purposes of performing administrative and other related functions relating to the offer of Shares under Section 287 of the Securities and Futures Act, Chapter 289 of Singapore (the "SFA") and such other functions as the MAS may prescribe.

You may not assign your rights under the Terms without our prior written consent. UBS Asset Management (Singapore) Ltd may assign our rights under the Terms to any third party.

No person or entity who is not a party to the Terms shall have any right under the Contracts (Rights of Third Parties) Act, Chapter 53B of Singapore or other similar laws to enforce any term of the Terms regardless of whether such person or entity has been identified by name, as a member of a class or as answering a particular description. For the avoidance of doubt, this shall not affect the rights of any permitted assignee or transferee of the Terms.

These Terms shall be governed by, and shall be construed in accordance with, the laws of Singapore. The courts of Singapore shall have exclusive jurisdiction to hear and determine any suit, action or proceeding, and to settle any disputes, which may arise out of or in connection with these Terms and, for such purposes, you agree to submit  to the jurisdiction of the courts of Singapore. Each party hereby waives any objection which it might at any time have to the courts of Singapore being nominated as the forum to hear and determine any proceedings and to settle any disputes and agrees not to claim that the courts of Singapore are not a convenient or appropriate forum.

© UBS 2019 - the key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.

Reset