FX market is too optimistic about trade talk

Economists warn that it is premature to wager on the US and China reaching an accord before 1 March
Chief Investment Office08 Feb 2019
Photo credit: AFP Photo

Foreign-exchange traders are too sanguine about the prospects for a trade truce between the world’s two largest economies.

That is the view of economists at the Institute of International Finance (IIF), who caution that it is premature to wager on the US and China reaching an accord prior to Washington’s 1 March deadline for a breakthrough. Treasury Secretary Steven Mnuchin is reportedly traveling to Beijing next week (ending 15 February) to continue discussions, less than three weeks before the US has said it will raise tariffs on USD200b worth of Chinese goods from 10% to 25%.

That risk to investors was on display Thursday (7 February), when the offshore yuan fell 0.1% against the dollar after CNBC reported that a meeting between US President Donald Trump and Chinese President Xi Jinping was "highly unlikely" to take place by 1 March. Yet despite the slide, the Chinese currency is still 1.3% stronger against the greenback this year amid optimism that the two countries can cut a deal.

The offshore yuan weakened to a decade-low of 6.98 per dollar in early November as relations between the US and China soured, heightening fears that a trade war would lead to a global slowdown. The Chinese currency has rallied to about 6.78 per dollar in the months since, with traders piling into bullish bets amid signs that tensions may be easing.

However, given that China still tightly manages its currency, it is a “bold call” to plough into long yuan wagers, IIF’s Robin Brooks warns. Recent yuan strength can be partly explained by negotiation tactics, according to IIF’s deputy chief economist Sergi Lanau, leaving investors vulnerable should talks fall through. – Bloomberg News.

The US Dollar Index (DXY) rose 0.12% to 96.51. The pound added 0.15% to USD1.2952 while the euro slipped 0.18% to USD1.1341. The yen strengthened 0.14% to 109.82 per dollar.

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