Trump's Tariff Threats Trigger Currency War, RMB Faces Depreciation Pressure

Trump has threatened to impose tariffs on China, Mexico, and Canada, with an additional 10% tariff on China. This policy is not specifically aimed at China but is linked to certain events. Following the tariff announcement, the Canadian dollar, Mexican peso, and RMB all experienced depreciation. The trade war could lead to a depreciation of the RMB, primarily influenced by the economic growth differences between China and the U.S., monetary policies, foreign exchange supply and demand, and central bank exchange rate policies. Although the RMB has recently depreciated against the dollar, this is mainly due to the strengthening of the dollar index rather than the tariff policy. By year-end, increased demand for foreign exchange by foreign trade companies and Chinese-funded overseas branches has supported the RMB exchange rate in the short term. In the future, increased tariffs may impact the RMB, and the central bank's response will be crucial.

Between November 2018 and September 2019, the RMB exchange rate fluctuated between 6.67 and 7.19. If a new round of tariff increases triggers a trade war, the RMB's reaction may differ from that of 2018. Changes in the strategies of market participants and the central bank will affect the exchange rate. After the escalation of the trade war in 2018, the market gradually abandoned optimistic expectations for resolution. This time, the market may quickly react to Trump's tariff policy, leading to significant adjustments in the RMB at the onset of the trade war. Since the exchange rate reform in 2015, the central bank has not adopted drastic one-time devaluations but has gradually guided the exchange rate using "counter-cyclical factors." The onshore RMB midpoint is influenced by the central bank's stance, and the use of counter-cyclical factors helps manage market expectations and reduce the consumption of foreign exchange reserves. On November 13, 2024, the central bank launched a new round of counter-cyclical factors to stabilize the exchange rate. Although counter-cyclical factors help manage expectations, frequent use may diminish their effectiveness. The central bank may also adopt other measures, such as increasing offshore RMB overnight lending rates, reclaiming foreign exchange purchase approval rights, tightening purchase review processes, and prompting offshore Chinese banks to sell dollars. Considering the changes in strategies by market participants and the central bank, the overall depreciation of the RMB is expected to be smaller than in 2018, but the specific extent will be influenced by various factors.

Transshipment trade is substantial, such as China's automotive exports to Mexico. Trump's tariff policies mention transshipment trade, which may reduce the buffer space in the trade war. If the U.S. does not negotiate, China may need to actively devalue its currency to offset tariff pressures, but this could trigger market depreciation expectations and impact the financial system. The U.S. may simultaneously pressure tariffs and exchange rates, making the RMB exchange rate a focal point of negotiations, with expected depreciation not being too significant.

The strength of the dollar index also affects the exchange rate. During the 2018 trade war, the RMB's depreciation was mainly caused by the strengthening of the dollar. Currently, the dollar is in a rate-cutting cycle, unlike the rate-hiking cycle of 2018, creating uncertainty about the future trend of the dollar index, which may impact exchange rates.

The stock market will also be affected by exchange rate policies. Central bank intervention in the exchange rate may raise lending rates, tighten liquidity, and lead to a sharp decline in the stock market. The Hong Kong stock market is influenced by the Hong Kong dollar's peg mechanism, where liquidity further tightens when the dollar strengthens. When market capitalization increases and indices are low, policymakers become more cautious about the stock market's impact.

The feasibility of fiscal stimulus policies is questionable. China lacks large-scale central fiscal policies, with debt reduction as a priority. Large-scale stimulus may raise debt concerns. If the trade war has significant effects, policies may shift toward short-term domestic demand stimulation.

Capacity reduction and international expansion are key to solving overcapacity issues. The trade war may passively reduce overcapacity to prevent escalation. Addressing overcapacity by exporting excess capacity and capital globally is a long-term strategy. The exchange rate serves as a balance for international payments, but domestic factors are more important to the public than the exchange rate.