RMB response - the unlucky number 7
Growth stabilization in China now hinges on the interplay between trade tensions and policy support. Although China is likely to maintain its policy of measured retaliation against US tariffs, it is clear that higher tariffs will weigh on China's short-term economic activity and planning. We expect the authorities to tone down its language about 'structural deleveraging' in the face of this uncertainty and to scale back their previous commitment to stabilize the renminbi in order to gain greater policy latitude.
On trade talks, the next key event is the G20 Osaka meeting between Xi and Trump. We believe the prospects of reaching a trade agreement in Japan are now dim. The likely outcome is that Trump will set another deadline of three to six months for a deal to be struck and if there is no agreement by that time, he will press ahead with the threatened tariffs on another US$300bn worth of Chinese goods.
Without a trade deal or material trade war de-escalation in the next three months, the RMB will break the USD-CNY 7 level in H2/19. Since RMB stability has been conditional on good-faith negotiations, we think Beijing may now choose to let the currency passively devalue against USD and the currency basket in order to partly offset the latest tariff escalation. However prior to the G20 summit China will defend the 7 level to avoid further inflaming tensions.
The Chinese authorities intervened to keep the RMB stable until the G20 summit. As we predicted a trade war 'truce' was announced but it did not last and China allowed the USD-CNY to fall below 7 on 5th August causing a mass sell-off in global risk assets.