DBS FX: Emotions run high but lack conviction over US-China trade spat

Philip Wee, FX Strategist, DBS Bank

The range-bound US dollar retreated for a second straight session. The DXY (USD) Index closed Monday 0.3% lower to 89.838, below 90 for the first time since 30 March. It is too early to conclude that US-China trade tensions have eased following the lack of an immediate response from China to the latest US threat to impose tariffs on USD100bn worth of imports from China. The market is, no matter how much it wants to, unable to fully subscribe to the Trump administration's optimism that a US-China trade war was possible but improbable. This was best illustrated by the Dow's failed attempt to recover last Friday's steep 575-point drop; the Dow retained only 44 out of its initial 436-point rally yesterday. As far as China is concerned, America started the tit-for-tat tariffs and that trade negotiations were not possible under the "current circumstances".

We remain wary of speculation that China may turn to exchange rates as the next battleground. China is said to be considering a gradual depreciation in the Chinese yuan or scaling back its purchases of US treasuries. Both scenarios do not sit in well with China's hard fought battle against one-way depreciation on capital outflows or one-way appreciation bets that encourages more debt. China wants to shift towards supply-side reforms and financial de-risking, towards more a sustainable consumption-based growth and a move away from debt-fueled investments and export-driven growth. On the other hand, China will also be looking to increase access to its markets, in particular, allowing more foreign ownership in the financial and manufacturing sectors. With the US threatening tariffs in trade negotiations, it has become less relevant if the upcoming US Treasury names China a currency manipulator in its upcoming currency report. On balance, there are no reasons to believe that China has deviated from its goal of achieving a two-way exchange rate.

For now, emotions still run high with little conviction, other than the realization that the DXY has yet to show signs of breaking out of its 88.5-90.5 range established since February. It is, however, becoming clear that America's trade disputes with China is different from its experiences with Japan. Japan never retaliated the way China did to US tariff threats and agreed to allow its yen exchange rate to appreciate to address trade imbalances. The US-China trade spat is increasingly viewed as an obstacle for both countries to avert the Thucydides Trap.

Source : Equity Bulls

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