The yuan devaluation is now a big risk for markets

Trump escalated the trade war further yesterday threatening additional 50% tariffs on China effective tomorrow if they don’t back off from the recent retaliatory tariffs. This move increased the risk of the yuan devaluation which could roil the markets if enacted.

China devalued the yuan back in 2015 to respond to an economic slowdown and boost exports. That move suprised the markets and sent them into risk-off as people feared that China’s economy was worse than expected. The US stock market reacted by falling more than 10% back then.

During the first trade war in 2018, the yuan kept on depreciating against the us dollar but in that case it was solely due to market forces (at least that’s what the Chinese said) and the PBoC even stepped in at times to prevent the yuan from falling too fast to avoid panic and capital flight.

Now we are in trade war 2.0 and Trump is pursuing a more aggressive policy against China. China doesn’t look like it’s backing down after it responded tit-for-tat with 34% retaliatory tariffs last Friday. Trump might have decided to take a gamble and threatened an additional 50% tariffs effective tomorrow if China doesn’t back off from the recent retaliation.

After imposing retaliatory tariffs last Friday, China vowed to use “more resolute” measures to protect its interests. That could be a hint for yuan devaluation. The counter-argument is that Chinese officials have been keeping the currency stable because they wanted to internationalise the yuan and avoid capital flight. But conditions have changed. Will their strategy change too?

If China pursues that strategy, then we could see the trade war escalate a lot further and Trump won’t be happy at all as he’s dubbed China a currency manipulator for a long time. The markets will likely expect something worse in response and the fear and uncertainty will likely weigh on the stock market further.

This article was written by Giuseppe Dellamotta at www.forexlive.com.