|14 August, 2019

Markets brace for currency war as yuan weakens

Lukman Otunuga is a research analyst at FXTM. A keen follower of macroeconomic events, with a strong professional and academic background in finance, Lukman is well versed in the various factors affecting the currency and commodity markets. Lukman holds a BSc (hons) degree in Economics from the University of Essex, UK and an MSc in Finance from London School of Business and Finance, where he studied corporate finance, mergers & acquisitions and the role of international financial institutions.

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As a consequence of slowing world growth, central banks are putting their monetary easing policies into overdrive

Warning signals flared in the financial markets after the Yuan blasted past $7 for the first time since May 2008, prompting investors to focus on the risks of an escalating currency war between the US and China.

Most recently, US President Donald Trump threatened to impose a 10 percent tariff on the remaining $300 billion worth of Chinese imports on September 1. As a result, China retaliated by ceasing all purchases of US agricultural goods and is considering imposing additional tariffs on other US exports to its vast territories.

In a further reaction, the yuan slumped against the dollar, provoking accusations from the US that China is a currency manipulator. China denies the accusations but after all’s said and done, trade negotiations in September appear to be hanging by the thread after Trump said it would be “fine” if talks were cancelled.

Changing economic relations

Testy economic relations have developed on a regional and global basis.

The US prefers a weaker dollar to make exports more affordable but is being outdone by the Yuan’s weakness. Internally, escalating tariffs have resulted in a significant slowdown in exports from the US to China.

One of the most vulnerable sectors is agriculture, which saw the value of exports to China drop by more than fifty percent to $9.1 billion from 2017 to 2018.  As a consequence of this and similar impacts on other economic sectors, the US and Chinese economies slowed in the second quarter.

In fact, trade disputes between the world’s two largest economies are entering their second year, dragging on global growth with a combination of supply chain disruptions and negative investor sentiment.

Meanwhile, the EU is seeking closer trading relations with China as the Asian giant’s trade disputes with the US wear on investors’ nerves.

In connection with the changing trends in trade relations, the US and EU have exchanged words over the levels of their respective currencies. Indeed, it could be argued that as the slowing global economy and trade disputes pressure exports, currency wars could spread to other major economic regions.

Monetary easing in overdrive

As a consequence of slowing world growth, central banks are putting their monetary easing policies into overdrive. The European Central Bank remains set on a course for negative interest rates, sapping the Euro of strength.

The Bank of England has more worries now that the economy contracted in the second quarter and the crumbling Pound Sterling reflects this vulnerability. Indeed, the GBP is being further crushed by Brexit posturing and the mounting risk of a disorderly exit from the European Union bloc.

As the global economic battle ground spreads from trade to currencies, a couple of different scenarios are possible. The first is much fiercer competition for exports, meaning lower commodity prices and more pressure on the financial markets amid a declining global growth rate.

The second is an unexpectedly rapid trade agreement between the US and China. This scenario is still in play given the unpredictable nature of the US-China trade disputes both now and in the past.

Under the current circumstances, investors in the GCC might expect the USD to weaken in accordance with interest rate cuts in the US. USD-priced oil revenues may come under pressure if a currency war is launched and the dollar’s value depreciates significantly against other currencies.

USD exchange rate advantages enjoyed during the era of a strong dollar may now dissipate in the headwinds of a currency war unless the trade is with much weaker currencies like the GBP.

All told, with no visible end in sight for the US-China trade disputes, the threat of a currency war becoming a reality is set to weigh heavily on global sentiment during the second half of 2019.

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