Although the Chinese central bank governor Yi Gang indicated that China would not use the exchange rate as a weapon for trade war negotiations, the renminbi exchange rate increase over “7” level and the US president was greatly angry. Trump then issued a message by social media to announce that the renminbi was manipulated by China and continued to push the Fed to cut interest rates. More and more market participants believe that the United States will consider intervening in the exchange rate to avoid falling behind in the currency war.
Where does the dollar depreciation pressure come from?
China has given up the “7” level of the Renminbi, and the Sino-US trade war has escalated, which has intensified the pressure on the depreciation of emerging market currencies. On the day when the Renminbi broke “7”, the Korean won depreciated more than 1.5%. If risk appetite goes down, it means that the dollar will have more pressure to appreciate against a basket of emerging market currencies. More importantly, this week, many countries in emerging markets held interest-rate meetings, and they all lowered the benchmark interest rate. Among them, India cut the benchmark interest rate by 35 basis points, and the central banks of the Philippines and Indonesia cut interest rates by 25 basis points and 50 basis points respectively. The sluggish inflation has caused central banks in emerging markets to gain room to cut interest rates and increase the relative spread between the United States and themselves.
A more important potential danger lies in the next move by the European and Japanese central banks. Although the monetary policy of Europe and Japan are very limited, the two countries are pushing for a new round of stimulus measures. In particular, the European Central Bank is more willing to further cut the benchmark interest rate in September. Therefore, if the euro falls below the 1.10 mark, the pressure on the dollar to appreciate is even greater.
Trump is dissatisfied with the dollar is too strong
As early as mid-July, the United States declined to intervened the exchange rate. Trump’s chief economic adviser Kudlow and Finance Minister Mnuchin, both opposed the US intervention in the dollar. However, the situation may be different. Trump began to worry that the strength of the dollar will affect economic growth in 2020, thereby reducing his chances in election. At present, the weighted trade dollar exchange rate has risen to a high level close to 2002, reflecting that US product export competitiveness has been eroded by a strong dollar.
If Trump considers intervening in the exchange rate, it cannot be achieved solely by the Ministry of Finance. Research shows that the Treasury has 94 billion assets, but the foreign exchange market transaction amount is 5 trillion per day. Even if the Fed is willing to bear the cost of intervention, it is very limited in terms of market impact. It is also difficult for Trump to incite the independence of the Fed and ask the central bank to join the task. Therefore, the US president can only continue to pressure Powell, and even increase the numbers of dovish officials, affecting the Fed’s decision on interest rates.
The impact of the currency war
The currency war is a zero-sum game. When one side seeks to obtain additional benefit from the exchange rate, other parties will seek various ways to retaliate. If the United States joins the camp that intervenes in the exchange rate, the world economy will be under further pressure. The current exchange rate volatility has touched a new low for many years, which is conducive to enterprises to manage exchange rate risks. Changing this environment will adversely affect the market sentiment. For the time being, everyone will use the interest rate cut to depreciate and will not publicly claim to intervene in the exchange rate. Undoubtedly, in this environment, the price of gold will rise as the real interest rate falls.