China’s Export Defense Will Slow Fed’s Offense

The yuan suffered its biggest one-day decline in more than two decades on Tuesday, hitting a three-year low after the Chinese central bank surprised markets by devaluing it by nearly 2 percent, firing a broadside in what some analysts saw as a looming currency war. This de facto tightening of monetary policy has eroded the competitiveness of U.S. exports, eaten into economic growth and diminished company profits repatriated from overseas.

Investors and others in the market expected China to take steps to untether its currency gradually from its trading bands, but were surprised that its central bank did so on Tuesday.

Devaluing the yuan adds to existing concerns about the China’s demand for commodities, pushing the currencies of commodity-exporting countries closer to multiyear lows.

Read also: • World shares slide on yuan move • Q&A: What does China’s yuan devaluation mean?

Their counterparts at Morgan Stanley (Xetra: 885836 – news) also said Asian currencies excluding the yen were likely to slide against the U.S. dollar. The central bank described this as a one-off move.

“The move signals that (China) is willing to use all available tools, including a weaker currency, to prop up exports and its domestic economy, ” said Eswar Prasad, an worldwide economist at Cornell University.

Though a weaker yuan might prompt complaints by foreign manufacturers, China’s central bank said its goal was to give market forces a bigger role – a step Washington has demanded.

The Australian and New Zealand dollars dropped sharply after China’s central bank set the midpoint for the yuan at 6.2298 per dollar, down from the previous day’s fix of 6.1162 per dollar, and said it was aiming for 2 per cent depreciation.

The center of Tuesday’s trading band was set 1.9 percent below Monday’s level. The Australian dollar fell 1.7% versus the greenback to US$ 0.7292. There should be further pressure on the currencies of China’s trade partners”, said Nick Lawson, managing director at Deutsche Bank (Other OTC: “DBAGF – news) in London. Chuck Schumer, a New York Democrat.

But given how anxious Chinese policy makers seem to be about…

“Treasury now has to choose which is more important”, said Chovanec, also Adjunct Professor at Columbia School of worldwide Public Affairs.

“While it is too early to judge the full implications of the change…”

Many in Congress have long accused China of unfairly building up its manufacturing sector at the expense of US jobs by undervaluing the renminbi, and the Chinese devaluation could fan those criticisms. Initiatives by Japan and the European Union over the past two years depressed the yen and euro.

Those moves contrast with action foreseen from the Federal Reserve, which is expected to boost the short-term interest rate it controls later this year. By making Chinese goods comparatively cheaper in the United States, a weaker yuan would push already-low U.S. inflation even lower. Inflation has risen just 1.3 percent in the past 12 months.

Michael Feroli, an economist at JPMorgan Chase, suggested that the dollar’s rise poses a concern for some Fed officials, known as doves, who have been reluctant to raise rates.

Investors have piled into the dollar with the conviction that the U.S. economy will strengthen enough for the Fed to raise borrowing costs for the first time in more than nine years.

“This is not good for U.S. inflation, which reduces somewhat the probability of a Fed rate hike in September”, said David Woo, head of global rates and currencies research at Bank of America Merrill Lynch.

Beijing will likely move cautiously, but market expectations of further weakening “could quickly become entrenched” and cause the yuan to “depreciate quite quickly and significantly”, Wang said.

She said that would represent a “sea change in China’s exchange rate policy” but would help to support flagging economic growth.