Is China’s currency weakness the latest salvo in trade tensions?

China’s currency, the yuan (CNY), has weakened 4-5% relative to the US dollar since June. This has prompted a lot of speculation that the authorities are deliberately weakening the currency in response to tariffs, and that this could mark the beginning of a series of devaluations for China. These fears are vastly overblown.

Official policy targets a basket of currencies, not a peg versus the US dollar

The first error made in this analysis is the assumption that China targets a peg versus the dollar. It does not. Official policy is to target a basket of currencies (essentially trade weighted) known as the CFETS basket. On this measure, the Chinese currency is only 2.5% weaker since June. 

Not only that, but as is visible from the chart below, this weakness is only reversing the strength seen this year. Since the CFETS basket was established in 2015, it has spent most of its time around the 94 mark. The deviation from currency policy has not happened in the last month and a half, it was the January - June period. 

CNYUSD vs CFETS basket

Recent CNY weakness a reversion to norm

So in a way, the press and other breathless analysts are right - trade tensions have been dictating Chinese FX policy. Just not in the way that garners headlines. Recent weakness is a reversion to the norm after a period in which the authorities deliberately allowed currency strength, presumably to avoid antagonising the US further at a delicate moment in negotiations. 

…but the currency could still be used to counter the effect of trade tariffs

We would not rule out the use of the currency as a weapon in the trade wars to come, but it remains under tarpaulin in the armoury for now. Should the CFETS pass through the 92 level, there will be more of a case to be made that China is aiming for currency weakness to counter US tariffs.

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.