News & analysis

Donald Trump added to the latest batch of market volatility yesterday by extending tariffs to cover all Chinese imports just hours after the Federal Reserve’s hawkish outlook on rate cuts. 

Volatility spiked in markets across all sub-sectors, with crude oil futures falling $3 and havens such as JPY rallying 1.6% in the aftermath.

The offshore yuan market burst into life also, with USDCNH rallying to 6.95 at one point in yesterday’s session, while this morning the PBOC surprised analysts by weakening the fix more than expected to 6.8996.

The discussion of USDCNY breaching the Y7.00 level looks stretched, even as the economy continues to fatigue under pressure of trade tariffs.

Chart 1: USDCNY is trading at levels not seen since November 2018 as the new tariffs pose further threats to a slowing Chinese economy

Given the recent bouts of fresh tariffs, which were far more damaging in terms of breadth and depth to the Chinese economy, the PBOC remained reluctant to allow the yuan to weaken past what is becoming a key psychological barrier for both markets and political experts. It is unlikely they’ll change tack even as their toolbox starts to empty.

The latest move by Trump to extend tariffs on the remaining $300bn worth of imports, ranging from goods such as apparel, toys and smartphones, was arguably facilitated by Powell’s move to lower rates in order to promote economic growth late on in the economic cycle.

Despite the Federal Reserve enticing Trump’s wrath due to not explicit signalling further rate cuts in the short-term horizon, the immediate reaction in trade policy suggests that more accommodative monetary policy paves the way for further growth negative tariffs on China.

If this is the case, it could leave many speculating that the latest round of tariffs would be more damaging than 10% if the Fed took a more dovish stance on Wednesday, adding another dynamic for the Fed to juggle.

This week’s events have all but confirmed our base case for US policy this year. A cumulative amount of 50 basis points shredded from the Fed’s benchmark rate looks the likeliest scenario as US data continues to show the product of the White House’s trade policies and that of a late-cycle economy.

However, a third rate cut by the Federal Reserve remains unsupported by the data thus far. It certainly can’t be written off by markets purely due to the unpredictable impact trade policy will have on the slowing US economy, but any decision will have to be made by the Fed sitting behind the curve.

With time running out, the data may not begin to support a third rate cut by the US central bank this year, skewing our view of a potential third cut into 2020 should the data deteriorate substantially.

That being said, trade policy may start to become more supportive for the US and global economy in 2020 as US politics enters into the new year with incoming elections.

Both the US and Chinese economies are beginning to show concerning effects of the trade war thus far and the mutual destruction thus far remains conducive to both sides to wrap up a deal in a timely manner.


Author: Simon Harvey, FX Market Analyst at Monex Europe.