Possible Currency War Would Be A Disaster For Oil
Oil prices plunged on Friday after the U.S. and China both announced tariff hikes in tit-for-tat fashion. At the same time, markets opened on a positive note early Monday after President Trump struck a more conciliatory tone. But the respite could be brief.
Global financial markets are completely at the mercy of Trump’s twitter account these days. On Friday, stocks and commodities fell sharply after China announced an increase in tariffs on U.S. goods. In response, Trump announced yet another 5 percent increase in the suite of tariffs on Chinese goods, although, notably, he waited until after financial markets had closed for the week.
Over the weekend at the G-7 Conference in France, Trump sent mixed messages on the trade war, suggesting he had “second thoughts,” with his team subsequently clarifying that his second thoughts regarded his regret he hadn’t hiked tariffs by an even greater amount. Nevertheless, traders took comfort in his comments about wanting to make a deal with China, in addition to his assertion that China had called him up asking for a return to negotiations.
Stocks opened up on a positive note on that news. However, it should be noted that Chinese officials said that they were “not aware of” the phone call that Trump alluded to. When pressed by reporters about the nature of the phone call, Trump said: “I don’t want to talk about calls. We’ve had calls. We’ve had calls at the highest levels.”
If we’ve learned anything over the past few months, it is that these events turn on a dime. The incoherent strategy from the White House, and the complete lack of an official policymaking process, makes it impossible to predict how events will unfold. It is odd then that financial markets were so sanguine at the start of the week.
One particular area of risk to watch is the further weakening of the yuan to the dollar. The yuan depreciated to 7.15 yuan to the greenback, the weakest rate since prior to the global financial crisis 11 years ago.
“It has been a bit of a roller coaster. We had the dollar opening up quite weak in Asia last night. Then a number of things have happened to reverse that including dollar/CNH pushing higher,” Daniel Katzive, head of foreign exchange strategy for North America at BNP Paribas, told Reuters.
“The gloves are coming off on both sides and as such yuan depreciation is an obvious cushion against US tariffs,” Mitul Kotecha, a senior emerging markets economist at Toronto-Dominion Bank, told Bloomberg news. “As long as China can ensure that yuan weakness is well controlled, i.e. it does not provoke strong outflows, expect to see further depreciation in the currency.”
Allowing the currency to depreciate is not without risks, even for China. With mountains of debt, a weaker yuan could make debt repayment at the company level more painful for Chinese firms.
But the global impacts are probably even more important to keep an eye on. Because of the importance of the yuan as a global currency, and because of the size of the Chinese economy, a weaker yuan will reverberate around the world. In early August, when the yuan initially weakened to the 7:1 level with the dollar following Trump’s announcement about new tariffs in September, the depreciation sparked an immediate response from multiple central banks. India, New Zealand and Thailand cut their interest rates in an attempt to head off a currency appreciation relative to the yuan. A week later, Mexico cut interest rates. Around 30 countries have already cut interest rates this year, according to Refinitiv and the New York Times.
Now that the yuan has dropped to roughly 7.15 to 1 with the dollar, there will be another round of pressure on emerging market currencies. For instance, on Monday, Turkey’s lira plunged by 12 percent relative to the Japanese yen. The China-U.S. trade war “means that EM FX will continue to weaken for the foreseeable future. In the absence of a thawing in trade frictions it remains a market to be structurally short EM and buy dollars on any dip,” currency analysts at Societe Generale said in a note.
“The hot and cold approach to negotiations continues and is creating a great deal of confusion,” said Ole Sloth Hansen, head of commodity strategy at Saxo Bank A/S in Copenhagen, according to Bloomberg. “At this stage we have to assume that tariffs will be raised, which is not good for growth and demand.”
It goes without saying that currency volatility and the risk of economic recession is bad news for oil prices. On top of that, China also just announced a tariff that specifically targets U.S. crude oil. “The escalating trade dispute is likely to weigh not only on the global economy and thus on oil demand, but also on US oil exports directly,” Commerzbank said in a note. “After all, China has been one of the largest importers of US crude oil in recent months.”
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