China: US Protests Yuan Weakness

Published on October 28, 2016
SGH Insight
US Treasury Secretary Jacob Lew and China’s Vice Premier Wang Yang appear to have held a phone conversation on Sunday night (October 23, Beijing time) to discuss the sliding Chinese currency, BIT trade negotiations, US elections, and US Treasury Bonds. While not an official protest over the weakness of the CNY, the call from Lew was, in effect, exactly that, and indeed was initiated at the suggestion of Washington.

Wang explained the reasons behind the slide in the currency to Secretary Lew, while keeping open the option of a further orderly decline if justified in the future. Wang also, however, expressed his “view” that the currency will likely trade between 6.6600 and 6.8000 for the rest of the year, with assurances of support in that period from China’s central bank if the CNY looked to be breaking 6.8000 again.
Market Validation
(FT 10/30/16) China’s central bank kicked off the week by strengthening the midpoint of the renminbi’s trading band against the dollar by the most in more than a week.

The People’s Bank of China set the fix around which the currency can trade 2 per cent against the dollar in either direction stronger by 0.32 per cent on Monday at Rmb6.76410.

That was the largest strengthening of the fix since Friday 21 October and follows a week that saw the midpoint move weaker overall by a 0.44 percentage points to 6.7850.
Our understanding from Chinese sources is that US Treasury Secretary Jacob Lew initiated a call to China’s powerful Vice Premier Wang Yang over the weekend.
*** The main purpose of Lew’s call was to question the recent depreciation of the Yuan, which is sliding regularly to new record lows and just hit a six-year low against the US Dollar on Friday. While not an official “protest” from Washington, the call was unofficially, in effect, exactly that. ***
*** Wang explained the reasons behind the slide in the currency to Secretary Lew, while keeping open the option of a further orderly decline if justified in the future. Wang also, however, expressed his “view” that the currency will likely trade between 6.6600 and 6.8000 for the rest of the year, with assurances of support in that period from China’s central bank if the CNY looked to be breaking 6.8000 again. *** 
The two sides also discussed the Bilateral Investment Treaty between the US and China, which is dead for all practical purposes for the remainder of the Obama Administration, US election risks, and China’s US Treasury purchases.
Vice-Premier Wang, as in the past, repeatedly assured Secretary Lew that China has no intention of dumping large amounts of treasuries anytime soon. 
A Protest Lands on Open Ears
US Treasury Secretary Jacob Lew and China’s Vice Premier Wang Yang appear to have held a phone conversation on Sunday night (October 23, Beijing time) to discuss the sliding Chinese currency, BIT trade negotiations, US elections, and US Treasury Bonds.
While not an official protest over the weakness of the CNY, the call from Lew was, in effect, exactly that, and indeed was initiated at the suggestion of Washington.
The timing of the call just might reflect a heightened degree of political sensitivity to China’s currency levels and policy in these last legs of a heated US election cycle.
And we suspect Chinese authorities also may not be averse to suggestions it will manage the pace of depreciation beyond 6.8000, in the process dampening speculative pressures and currency outflows, at least for now. That is, of course, all within the context of a market-oriented currency.
Managing Currency Pressures
 
In what appear to be unusually blunt terms, Secretary Lew is said to have stressed the recent RMB (Renminbi, or Yuan) depreciation has exceeded the US side’s expectations.
 
Lew expressed US concerns over continued RMB depreciation, and asked that China make clear there will be no further declines against the dollar – at least for this year.
 
Wang assured that although the RMB had weakened to six year lows against the dollar on Friday, there would be no further sharp drop despite persistent depreciation pressures.
 
In addition to pointing to a strong dollar in general and growing expectations for Federal Reserve rate hikes, Wang attributed recent RMB weakness to market forces and recent Chinese reforms that allow for a more market oriented exchange rate mechanism that, by definition, leads to greater volatility. In other words, remember you got what you were all asking for…
 
Wang nevertheless reassured that despite some short term volatility from a stronger dollar, he expects the RMB to maintain its overall stability, with no chance of a sharp depreciation.
 
Lew asked for further clarity and questioned what type of fluctuation exactly the US could expect? Wang offered his “personal view” the RMB could fluctuate between 6.6600 and 6.8000 for the rest of the year, and assured there would be strong and solid support to keep it from sliding beyond the 6.8000 level.
 
In the big picture, Wang re-emphasized there was no possibility of a drastic depreciation of the currency, and pointed out that the RMB continued to be supported by stable economic growth, balanced fiscal conditions, and ample FX reserves.
 
He noted that China could tolerate a more orderly depreciation of the currency in the future if needed, but would intervene on occasion in case of drastic fluctuations. And he again stressed that despite having reached the lowest level against the dollar in six years, there was no basis now for any persistent decline in the RMB.
 
Wang finally observed, perhaps pointedly, that the RMB has been more stable than any of the “other major” currencies.
 
BIT, Bonds and Elections
 
With the Obama Administration’s term running to a close, the two sides also took stock of the stalled Bilateral Investment Treaty (BIT) negotiations, and touched on US election risks and US bond markets.
 
On the BIT, Wang expressed that while China remained committed to carrying forward negotiations on a mutually beneficial, win-win and high level basis with the United States, Beijing would remain firm in its opposition to the Obama administration’s terms for a so-called “negative list” that is part of the BIT Treaty.
 
And even while the two sides are in the last stages of completion of the treaty, the 10-15% level of disagreement that remains over the final list appears to be insurmountable.
 
Regardless, in the current political climate of anti-trade sentiment, and with less than three months remaining in the Obama term, Chinese officials understand there is simply no room or time left to complete BIT negotiations. And even if they miraculously were to do so, it would be impossible to get it through a hostile Congress.
 
In effect, the BIT Treaty is dead, at least for now, and will be left to the next President to resurrect, if she or he wishes.
 
The Chinese side also questioned Secretary Lew on the possibility of a Trump victory in the US Presidential elections.
 
More specifically, Wang asked if despite the current polls showing Secretary Hillary Clinton in the lead, Treasury had any contingency plans in place to deal with market turbulence in case of a “black swan” event were for some reason that not to be the case?
 
Lew, not surprisingly, expressed confidence Clinton would win, and promised to keep in close contact in case of a surprise.
 
Finally, Chinese officials believe their US counterparts are worried Beijing may dump large amounts of bonds in the future, or more to the point, in the remainder of the Obama term.
 
Wang repeatedly assured that China has no intention of dumping US Treasuries, and reminded Lew of Beijing’s commitment to inform the US if China were to sell more than $30 billion of US bonds within any given month.
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