Yuan bears are finding a friend in Donald Trump. A measure of expected volatility in the Chinese currency jumped to the highest in three months, while forwards weakened to a seven-year low, after Trump’s win stoked speculation a more protectionist US will prompt China to allow steeper declines to support growth. The Republican victor has threatened to call China a currency manipulator on his first day in office and impose 45% tariffs on the nation’s imports.
Increased costs for trading with the country’s top export destination would deal another blow to the Chinese economy, which is already suffering from weaker global demand for the nation’s products and an over-reliance on debt for growth. While Trump has lambasted China for keeping its currency artificially weak, the authorities have sought to slow losses by tightening outflow controls and intervening to sell dollars.
“If the Trump administration were to label China as a currency manipulator or to slap more hefty tariffs on China, then eventually China could potentially retaliate by just not intervening in the currency and letting the currency weaken,” said Dennis Tan, a foreign-exchange strategist at Barclays in Singapore. “China is not intervening now to prevent the currency from strengthening; it’s intervening to prevent it from weakening.”
The onshore rate dropped 0.4% to a seven-year low of 6.8443 yesterday, beyond the 6.83 peg where China held the exchange rate in the aftermath of the global financial crisis, after the People’s Bank of China weakened the fixing to the lowest since 2009. A slowdown in trade under Trump would spur more aggressive monetary easing, driving further currency weakness, according to Deutsche Bank and Daiwa Capital Markets.
For most emerging markets including China, a Trump presidency could deliver the double whammy of faster capital outflows and narrower trade surpluses. The greenback has surged along with bond yields since his stunning victory on expectations the Federal Reserve will tighten monetary policy more quickly as Trump’s proposed spending boosts inflation.
Options and forward markets, which had remained unruffled in recent weeks even as the yuan weakened, are finally pricing in steeper declines. The yuan’s one-year implied volatility, a measure of expected swings used to price options, has jumped 1.08 percentage points since Trump’s triumph to reach the highest since July. Twelve-month non-deliverable forward points rose to 2,231 points on Thursday, the highest since June.
For now, the PBoC seems to be maintaining its usual strategy of containing excessive volatility. The yuan gained 0.6% versus a basket of 13 currencies last week after three weeks of declines. While the exchange rate will be relatively stable in the short term because China tends to take a more conservative approach when there are large swings in other Asian currencies, the longer-term picture is grimmer, said Paul Mackel, head of emerging-markets currency research at HSBC Holdings in Hong Kong.
“If you have a very extreme outcome – that is a significant deterioration in US-China trade relations and investment disruption – you could have significant renminbi volatility and the depreciation pressures could be a lot more pronounced than the market is currently thinking,” he said.
Of course, it all depends on whether Trump’s actions will match his words. It’s too early to worry about trade barriers as campaign rhetoric is often unreliable and the government will probably decide against any measures that risk sparking a trade war, according to a note by Bank of America Merrill Lynch analysts led by Helen Qiao.
The spectre of trade curbs is just one of the factors pushing down the yuan. China’s foreign-exchange reserves fell the most since January last month, a sign capital outflows are quickening again. Economic growth this year is already set to be the slowest since 1990. And even near-record trade surpluses are providing little support to the yuan as exporters convert less of their foreign-exchange earnings into the domestic currency amid fears of depreciation.
In the wake of Trump’s win, Morgan Stanley recommended shorting the offshore yuan against the dollar as markets price in more uncertainty for trade-dependent economies. Deutsche Bank suggested the same trade, as well as selling the offshore exchange rate against a trade-weighted index, noting that the yuan “is the most notable mispricing in the region.” The yuan in Hong Kong fell 0.4% yesterday to 6.8528 per dollar.
“Once the dust settles on the immediate fallout from the elections, the markets will need to refocus on the deterioration in the capital outflow picture in China,” Deutsche Bank strategists led by Sameer Goel wrote in a note. “A Trump presidency should increase the risk premium on worsening in US trade relations with rest of the world, and in particular with China.”