With a weak yuan and strong US data, Trump might have to accept a higher dollar, like it or not

Neal Kimberley says the strong American economy and a soft Chinese currency justify a case for an even stronger US dollar. Trump’s tariffs have not eroded the US trade deficit and he needs to keep an eye on the yuan

PUBLISHED : Tuesday, 11 September, 2018, 1:01pm
UPDATED : Tuesday, 11 September, 2018, 10:32pm

“Unprecedented Jobs Growth Streak Continues as Wages Rise”: That was how the White House trumpeted US jobs and earnings data last Friday. The currency market could conclude that such data justifies a yet stronger US dollar, including against the yuan. That might not play well in the White House but the Trump team would have to accept it.

A stronger greenback makes imports into the United States cheaper for US consumers, and partly offsets President Donald Trump’s trade tariffs that increased the prices of affected imports.

As it stands, there are few signs anyway that Trump’s trade war, and tariffs, are eroding the US trade deficit. Indeed, this deficit hit US$50.1 billion in July, a five-month high, US Commerce Department data showed. The US goods deficit with China is at a record US$36.8 billion.

As for the US jobs data, a healthy addition of 201,000 jobs across sectors except agriculture in August, a low unemployment rate of 3.9 per cent and, perhaps most importantly, an annual increase of 2.9 per cent in wages – the biggest jump since 2009 – all strengthen the case for two further interest rate hikes this year.

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Markets are now pricing in both the near certainty of a US rate increase when the Federal Reserve makes its announcement on September 26 and a higher likelihood of a further rate hike in December.

Even before last Friday’s data, Chicago Federal Reserve Bank president Charles Evans was arguing that the US central bank would have to raise US interest rates “toward a neutral setting and then likely a bit beyond neutral”. He feels 2.75 per cent would be “neutral”; the Fed’s benchmark overnight lending rate is currently in a range of 1.75 to 2 per cent.

In the currency space generally, and with specific regard to the US dollar-yuan exchange rate, this may all prove decisive.

Writing ahead of Friday’s US data, Japan’s biggest bank, Mitsubishi UFJ Financial Group, said “the primary driver behind USD/CNY remains interest rate differentials”. It expected Chinese onshore rates to “remain low” even with two more US rate hikes in the year. Unimpressed by the macro-prudential measures thus far taken by Beijing to slow the pace of yuan depreciation, the Japanese firm currently envisages a US dollar-yuan rate of 7.00 in the first quarter of 2019 and 7.05 in the second quarter.

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And while the Trump administration wouldn’t be rapturous about such yuan depreciation, the currency market could rationally decide that such a move, driven by the US dollar’s strength and the yuan’s weakness, would be fully justified. But the White House might be even more discomfited if such a move was more the result of a soft yuan than a strong dollar, as might be construed if the renminbi fell against not only the greenback but also other currencies like the euro.

According to French bank Societe Generale, the yuan matters more now than before 2015, when the Chinese currency “didn’t correlate much with broader dollar trends, and had relatively little influence over what happened to other markets”. But with the growing importance of the Chinese economy, the yuan also has bigger impact on global currency trends.

Last Thursday, the French firm argued that “it isn’t a coincidence that [the euro-US dollar] ran out of steam when [the US dollar-Chinese yuan] reached its low point in February and started to fall as the yuan weakened in April; or that the high in [the US dollar-Chinese yuan] and the low in [the euro-US dollar] came on the same day”.

And that’s potentially bad news for the Trump administration.

In short, for the euro trade-weighted index to remain relatively stable amid a rise in the euro-yuan, then the euro-US dollar would probably have to edge lower to compensate.

In current circumstances, a weak yuan, together with buoyant US data and the likely tightening of US monetary policy, could end up mechanically re-energising demand for the US dollar on the foreign exchange markets, undermining US competitiveness in the process.

The White House would probably want to avoid that but, to quote the Rolling Stones song Trump is fond of using at his rallies, “you can’t always get what you want”.

Neal Kimberley is a commentator on macroeconomics and financial markets