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You’re the Currency Manipulator!

August 12, 2019

Last Week This Morning

  • 10 Year Treasury plunged into the 1.60%’s before rebounding to close out at 1.75%
    • German bund down again to -0.58%
    • Japan 10yr down slightly to -0.22%
  • 2 Year Treasury dropped into the 1.50%’s before rebounding to close out at 1.65%
  • LIBOR at 2.19% and SOFR at 2.09%
  • China announced it would peg the yuan to the dollar at a 7:1 exchange rate, causing the US to retaliate by labeling China a currency manipulator
  • India, Thailand, and New Zealand all cut rates more than expected
  • Denmark-based Jyske Bank announced negative interest rates for mortgage borrowers.
    • Yes, that’s correct. Borrowers will repay less than they borrow and the world is officially broken.


You’re the Currency Manipulator!

For the first time since the Cowboys last won a playoff game, the United States formally named China a currency manipulator.

“Secretary Mnuchin, under the auspices of President Trump, has today determined that China is a Currency Manipulator,” the Treasury Department said in a release. “As a result of this determination, Secretary Mnuchin will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China’s latest actions.”

“In recent days, China has taken concrete steps to devalue its currency, while maintaining substantial foreign exchange reserves despite active use of such tools in the past,” the Treasury Department added. “The context of these actions and the implausibility of China’s market stability rationale confirm that the purpose of China’s currency devaluation is to gain unfair competitive advantage in international trade.”

I’m no economist…but this doesn’t sound like good news if we were rooting for a trade war resolution.

The technical implications are likely minimal.  From here, the US files a complaint with the IMF.  The IMF will then begin an investigation with actual penalties being unlikely.  The IMF will have a challenging time proving that China is engaging in currency manipulation because Xi will just say, “Hey, our economy is slowing and this is one of the tools that everyone uses to fend off recession.  If we’re guilty, then the US is guilty because the Fed is cutting rates to weaken the dollar.”

“I’m not the currency manipulator!  YOU’RE the currency manipulator!”  Doesn’t have quite the same ring as “You’re the puppet!”

More importantly, this sends all sorts of signals about the trade war.  China is clearly suggesting there is no resolution in sight.  It would not poke the Trump bear so blatantly if it expected to resolve the issues of tariffs anytime soon.

You may recall that China intervened aggressively in 2016 to prevent the yuan from breaching the key psychological level of 7 yuan to US dollars.  One of its key mechanisms to accomplish this is to buy Treasurys, which is why rates plunged back then.  Today, the market is wondering – if China’s willing to weaken beyond 7 now, what’s the bottom?  Why would traders sell Treasurys right now when China is buying?  Where else is China going to spend its money?  German bunds are yielding negative 0.58%, so a 1.75% 10T looks pretty good.

I doubt China will allow the yuan to fall much further because at some point it spooks investors so much that capital exits en masse and only exacerbates the issues its own economy are facing.  It also diminishes the yuan’s standing in international markets.  I think China’s trying to walk a fine line between sending the US a message without causing full-blown panic.  But as my father in law likes to say when he is stomping me in a game of pool, “Don’t get cute with it.”

As we wrote more than a year ago when Trump first threatened tariffs, both countries stand to lose…but China stands to lose more.

That being said, Xi doesn’t have to deal with those pesky democratic elections and is likely digging in to wait out the 2020 elections here.


QE4 Ahead?

If Powell doesn’t follow Trump’s orders suggestions by cutting rates more aggressively, at some point Trump is likely to start calling for another round of QE to help prop up equities.

And banks like BofA and JPM both released reports last week suggesting the Fed may be forced into additional rounds of QE in order to offset upcoming cash shortage.  Here’s a graph from JPM’s report illustrating how the US money supply has turned negative.  The last time this occurred in 2012, the Fed launched QE2, which led to Operation Twist, and ultimately QE3.



Markets are pricing in a 100% probability of a rate cut at the September 18th FOMC meeting.  By year end, the odds of Fed Funds being 1.50%-1.75% are currently priced at 54%.

The 10 Year Treasury has little reason to rebound materially unless we see some good news on the trade war front.  The floor on the 10T is still 1.62%, so keep an eye on that if the situation deteriorates.


Week Ahead

CPI, retail sales, and consumer confidence are the economic highlights, but will take a backseat to issues with China.


Click to Open: The Pensford Letter PDF