FX Update: CNY breaks floor, volatility ramps

USDCNY trades above 7.00 for first time in over a decade

In direct response to US President Trump’s latest tariff threats, China has abandoned support for the renminbi exchange rate, allowing the USDCNY to pull above 7.00 for the first time in over a decade (early 2008 was the last time it traded near current levels). From the Chinese side, the PBOC stated that the yuan move was “due to the effects of unilateralist and trade-protectionist measures and the expectations for tariffs against China.” The absolute magnitude of the CNY drop was not overwhelming – at 7.025 some 1.5% from Friday’s close as of this writing, but the signal value of the move is enormous as it now represents a bilateral escalation of the conflict that becomes all the more difficult for either side to climb down from. The offshore yuan traded somewhat more aggressively higher, reaching as high as 7.11 overnight. How much the move further impacts risk appetite will depend in part on how far China allows its currency to fall. A move to 7.10-15 followed by clear stabilization efforts has far different implications from a larger move with significant daily two-way swings.

This massive escalation in the US-China showdown comes at an awkward time for global markets, which have engaged over prior months in an orgy or risk-taking and celebration of the Fed and other major central banks moving into a full throttle easing cycle. Already, equity markets and emerging market currencies are reacting strongly negatively to this turn of events, and that development could deepen badly, given the heights we have come from in complacency. From here, we’ll also keep an eye on corporate credit spreads and other measures of risk, many of which have shown little volatility. In currencies volatility has certainly picked up from near- or actual record levels, especially in JPY, and this may only be the beginning.

But most importantly, this latest response from China to Trump’s trade tariff threat accelerates the path to a major intervention into the level of the US dollar from the Trump administration – so the “USD as safe haven” may have limited legs against risky currencies. Headline (and Tweet-) risk is high.

Chart: AUDJPY weekly

AUDJPY is the classical risk-on, risk-off currency within the G10 and is playing its role to the hilt at the moment. Adding to the fundamental woes Down Under, the US-China showdown has finally begun feeding more forcefully into commodity prices, as iron ore, Australia’s largest export, saw  prices tumble steeply overnight. The pair, not including the flash-crash in JPY and AUD crosses at the beginning of this year, has punched a 10-year low this morning and the 72.00-50 area looks a bit like a multi-year head and shoulders neckline. The RBA meets tonight and a surprise rate cut could add to the downside risk.