Dollar Rebounds as Analysts Contemplate a Currency War 

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- USD rebounds as FX roles reverse in wake of CNY devaluation.

- USD retakes ground from safe-havens as risk currencies recover.

- GBPUSD shares in recovery of low-yielding and riskier G10 units.

- As analysts contemplate odds and implications of a currency war. 

The Dollar rebounded strongly on Tuesday as currency market roles appeared to reverse in the wake of the Chinese Renminbi devaluation seen at the beginning of the new week, although the outlook is still shrouded in uncertainty as analysts contemplate the odds and implications of a possible 'currency war'. 

America's Dollar recovered ground previously lost to safe-haven currencies like the Japanese Yen and Swiss Franc as well as relatively high-yielding rivals such as the Canadian Dollar as a newfound calm swept through markets following the daily 'fixing' of the USD/CNY rate by the People's Bank of China (PBOC).

The PBOC set trading band midpoint for its USD/CNY onshore exchange rate at 6.9683 Tuesday, up significantly from the 6.9220 but below the psychologically important 7.0 level that was crossed over amid trading of the exchange rate during the Monday session

"China has used a combination of higher offshore RMB rates and the USDCNY mid-rate to put the brakes on RMB weakness, but we believe that this would have been the case even in the absence of the US Treasury naming China a "currency manipulator". One of the last things China wants is to set off a wave of emerging market devaluations," says Stephen Gallo at BMO Capital Markets.

Above: Dollar Index shown at daily intervals alongside USD/CNH rate (yellow line, left axis).

The earlier decision to let the Renminbi slide on Monday forced the Dollar higher against the Chinese currency and everything even remotely correlated with either it or investor risk appetites, which saw the Pound as well as others like the Australian and New Zealand Dollars suffer losses early in the new week.

Earlier declines were in reverse Tuesday, with the greenback's losses to safe-havens like the Yen and Swiss Franc also correcting, but the outlook for currencies and the global economy remains shrouded in uncertainty.

Tuesday's rebound came despite the U.S. designating China a 'currency manipulator', which analysts say will matter little now to the nation's leadership because all Chinese exports have now been clobbered by U.S. tariffs. 

"It is possible that Trump has a desire to be seen to be taking a firm stance against China for his domestic audience ahead of next year’s election. It is also possible that China’s decision to allow USD/CNY to slide above the 7 level yesterday was a warning to the US, that the currency could be used as a weapon in the ongoing trade war between the two countries," says Jane Foley, head of FX strategy at Rabobank.  

Above: Pound-to-Dollar rate at 4-hour intervals alongside AUD/USD rate. 

Dollar volatility, and this week's falls in the Chinese currency, followed a decision by President Donald Trump to impose a 10% tariff from September 01 on the remaining $300 bn of goods the U.S. imports from China each year. 

The tariff decision, which came after U.S. negotiators came away empty handed from talks over "unfair" practices with their Chinese counterparts, is threatening further pain for both the global economy.

Chinese and global growth has slowed across this last year as the world's two largest economies came to blows over trade practices.

Trump already imposed tariffs of up to 25% on some $250 bn of China's annual exports to the U.S., citing "unfair" practices that include the alleged theft of international property among other things. 

He now claims China has failed to deliver on a series of earlier commitments allegedly made to the White House including one have state-owned-companies buy more agricultural products from American farmers. 

"China is the world’s largest importer of commodities and a considerable consumer of goods produced in the Asian region. A weaker CNY could thus prompt a broader currency war. US President Trump has actively used verbal intervention this year in an effort to push down the value of the USD," Foley warns. "If trade tensions and slowing world growth were to trigger a broader rout in risky assets, the USD is likely hold firm against a large basket of currencies – though the safe haven JPY and CHF would likely be the major beneficiaries."

Above: USD/JPY rate at daily intervals, alongside USD/CNH rate. 

August's threat of further tariffs came conspicuously on the heels of the July 31 Federal Reserve (Fed) interest rate decision and statement on the outlook, which prompted yet more criticism of Chairman Jerome Powell by President Trump, who appointed America's top policymaker to his post in early 2018 following a selection process.  

"It is quite correct that the dollar should be under pressure, as - together with the CNY - it is at the centre of the conflict. The euro is the surreptitious winner: it is currently on the side-lines and has been able to appreciate on a broad basis," writes Antje Praefcke, an analyst at Commerzbank, in a note to clients.

The Fed cut its interest rate 25 basis points to 2.25% last week but told markets it has not begun a cycle of rate cuts before hinting strongly that the 100 basis points of reductions to the Fed Funds rate that financial markets had come to expect is not nearly the done deal some thought it was. 

President Trump has increasingly criticised the Fed for lifting its interest rate four times in 2018, at a time when the government was cutting taxes in order to boost the economy, given the impact that it's had on American households' capacity to spend as well as the U.S. Dollar. 

Those hikes came at a time when the trade war was slowing economies elsewhere in the world, reinforcing market expectations that other developed world central banks would simply remain sat on their hands, which helped lift demand for the Dollar. 

"Speculation on the market that the US Treasury might intervene on the FX market is likely to rise, though, principally putting pressure on the dollar. The market is now pricing in a further three Fed rate cuts," Praefcke says.  



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