Markets are watching China's monetary policy as yuan hits 4 month low

Cornelia Mascio
Mag 15, 2019

In new developments, Trump called on the Federal Reserve to "match" what he said China would do to offset economic hardship being caused by tariffs. Have a quick read about that here from the South China Post.

The specter of Treasuries being deployed as a weapon in the trade spat surfaced via a tweet from a Chinese journalist on Monday that said the nation's scholars are "discussing the possibility of dumping" USA government debt. Old school thinking says gold rallies during times of geopolitical turmoil, but new school thinking says that gold prices are controlled by interest rates.

And right now, there are plenty of those.

"Consider it China's nuclear option in the trade war with the US - the ability to start dumping its massive pile of Treasury bonds that could trigger a surge in interest rates and substantially damage the American economy". That has increased fear in markets that any further escalation could seriously jeopardise the global economic recovery before numerous world's central banks have had a chance to normalise monetary policy. The dollar rose and Treasuries fell. Beijing on Monday said it will increase levies on some American goods in retaliation for the latest US tariff hikes. Most analysts downplayed such a move, which would send U.S. borrowing costs soaring, strengthen the yuan and hurt Chinese exporters.

Here, China has an additional advantage in this regard with its ability to set the fixed exchange rate. Treasuries and the yuan steadied.

It's quite ingenious and is one of the reasons why China and other exporters have such large sums of treasuries to date.

Societe Generale estimated that should the current tariffs remain in place, the United States economy will be harmed to the tune of 0.25 per cent over a two-to-three year horizon, compared with 0.5 per cent in China.

That is why President Donald Trump should not only tell China to "bring it on" when it comes to dumping treasuries, he might also consider having the U.S. Treasury label China a currency manipulator and bar it from purchasing any more treasuries.

After all, China needs to keep buying treasuries to exert its trade advantage.

Currencies The Bloomberg Dollar Spot Index gained 0.2 per cent to the highest in more than a week. Ten-year Treasury yields edged higher to 2.42%.

And there's the question of where China would put its money - all that cash would have to go somewhere, and US bonds are among the highest-yielding in the world when weighed against their relatively low risk.

Sebastien Galy, senior macro strategist at Nordea Investment Funds, also sees the risk that China will trim its Treasuries pile if it needs to prop up the yuan to prevent repercussions for its economy. "Markets would like a little bit more play nice and maybe even a bit of complacency from China". It's not leverage, it's suicide. We don't need China to buy USA debt.

Robert Romano is the Vice President of Public Policy at Americans for Limited Government.

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