Canadian Dollar Favoured While Yuan Wreaks Havoc in Markets

Foreign exchange strategist concerned that currency war could become economic war
By Rahul Vaidyanath, Epoch Times
August 7, 2019 Updated: August 7, 2019

News Analysis

The worst sell-off in U.S. stocks in 2019 happened this week amid rising trade tensions between the United States and China, but also closely watched was the yuan’s slide against the U.S. dollar.

The Chinese regime allowed its currency drop to just over seven to the U.S. dollar. Its fall sent a ripple through financial markets, which had investors seeking safe havens such as U.S. Treasury bonds and gold, which hit a 6-year high.

However, the net impact on the Canadian dollar is probably quite small, says Greg Anderson, global head of foreign exchange strategy at BMO. In this market panic, Canada’s loonie gets pushed higher due to the U.S. Federal Reserve being expected to cut interest rates more aggressively than the Bank of Canada. But it also gets pulled lower because it doesn’t tend to do well when fear rules markets. Anderson says the two competing forces are roughly even.

With China having repeatedly propped up its currency for years, the yuan breaching the symbolic 7-per-dollar threshold happened for the first time in 11 years on Aug. 5.

“For them to let it go [allowing the mini devaluation] is sort of a way for China—pick your way of interpreting it—[to indicate that] things are a lot worse than they were before or we’re at a new level of exasperation with the Trump administration,” Anderson said.

Steady Loonie

Throughout the trade tensions, global uncertainty, and weakening growth, the Canadian dollar has remained stable within a 5 percent range in 2019. Large moves in the currency tend to be driven by international events.

Canadian financial markets were closed Aug. 5, but they played catch-up on Aug. 6. Up to that point, the Canadian dollar was up 3.4 percent in 2019—among the best-performing currencies just behind the Japanese yen.

Investors who had been borrowing euros to buy Canadian dollars, on the expectation that the loonie would outperform the euro, have been quick to close out that trade and take profits, says Anderson. He himself is reinitiating that popular trade, noting that the economic fundamentals of Canada and Europe haven’t changed.

People used to think of the loonie as a “petro-dollar,” going up and down with the rise and fall of oil prices, but that hasn’t been the case in 2019. Now the only time the two move in tandem is when oil prices move more than US$10 a barrel, says Anderson.

However, one potentially significant event for the loonie is the October federal election. A good economic plan could give the currency a boost, but financial markets aren’t suggesting anything for now.

Currency Wars

Countries around the world want weaker currencies to try to stave off slower growth. Following the Fed rate cut of July 31, central banks from India, Thailand, and New Zealand cut rates on Aug. 7. Thus far the Bank of Canada has remained neutral on its next move, though Capital Economics expects three rate cuts starting in October until the end of 2020. Financial markets were quick to price in two in the same timeframe.

Anderson says that the “polite and almost cooperative jockeying” by policy-makers to weaken their currencies has given way to something far different, and “currency wars” or a “race to the bottom” is no exaggeration.

“Countries are being much more direct about what it is that they want or they’re trying to do, and I do worry that it goes from a currency war into an outright economic war,” Anderson said.

The worry, he says, is if the parties involved can’t de-escalate. But U.S. President Donald Trump has shown that he can, as evidenced with North Korea; however, each leader has subordinates who are entrenched in their positions.

“Trump has been very careful to never make it personal and goes out of his way to like Xi, be friends with Xi,” Anderson said.

The president and the U.S. Treasury called China a currency manipulator for devaluing its currency to gain an unfair advantage in international trade. A cheaper yuan makes China’s exports—which are subject to U.S. tariffs—cheaper to buy with foreign currencies.

In an Aug. 5 interview with CNBC, Kyle Bass, founder of hedge fund Hayman Capital Management, said the Chinese have been negotiating with the United States in bad faith all along and “never lived up to one thing they said they would do.” In his analysis, the Chinese are running out of U.S. dollars to sell in order to support the yuan.

Follow Rahul on Twitter: @RV_ETBiz