Trade wars increase focus on currency

Global trade tensions continue to bubble away and it remains unclear just how much further they may escalate. What is becoming increasingly evident is ‘trade wars’ threaten to also to reopen ‘currency wars’.

The latter has been a point of contention between central banks since the Global Financial Crisis. The tension came about as banks aggressively pursued accommodative and in many cases unconventional monetary policies that were designed, in part (whether admittedly or not), to put downward pressure on exchange rates. Indeed, major central banks still remain vigilant against what they see as undue appreciation of their currencies impacting financial conditions and real economic performance.

Now, anxieties about currency are threatening to return to prominence as the US Administration becomes increasingly concerned and vocal about the appreciation of the US dollar (USD) against other major currencies. This comes despite the appreciation in the USD being an entirely expected consequence of the US Federal Reserve (Fed) raising interest rates and the US economy outperforming global counterparts. This is especially true given markets have increasingly (but not entirely) priced in the Fed’s expected policy rate path since late 2017 as US economic and inflation outcomes have strengthened.

US: USD and market Fed funds rate pricing
Markets expecting more rate hikes has supported USD appreciation


Source: IFM Investors, Bloomberg, Macrobond

Nonetheless, the US President and his administration have stepped up the rhetoric. The former noting on social media in July that “China, the European Union and others have been manipulating their currencies and interest rates lower, while the U.S. is raising rates while the dollars gets stronger and stronger with each passing day – taking away our big competitive edge. As usual, not a level playing field...” (sic).

Treasury Secretary Steven Mnuchin backed these comments, noting the Treasury will be “closely monitoring” the depreciation of the Chinese yuan renminbi (CNY) in particular. Indeed, the CNY has depreciated significantly against the USD over recent months, declining by as much as 9¼% since late March lows. This movement is in excess of the USD’s relative strength against other currencies, prompting the US President to again take to social media and describe the CNY as “dropping like a rock”.