(Bloomberg) -- The Trump administration’s unexpected move to designate China as a currency manipulator has raised the risk of direct U.S. intervention in the foreign-exchange market, analysts agree. What’s less clear is how to drive up the yuan itself.
President Donald Trump’s team has a record of surprises on executive action, so it would be risky to rule out any option. But foreign-exchange experts highlight the difficulty of a surgical operation targeted at China’s currency. The yuan isn’t as easily tradeable as the currencies of developed nations, one reason why foreign ownership of China’s bond market -- the world’s second largest -- is still only roughly 2%.
“It’s very improbable at this stage” that U.S. authorities would use their access to the onshore Chinese bond market to purchase government securities, said Mansoor Mohi-uddin, senior macro strategist at NatWest Markets in Singapore. “There’s more bang for the buck in euros, yen or Swiss francs or the pound -- and by doing that sending a signal to the CNY and CNH market that the dollar is weakening.”
“CNY” is the code for China’s onshore yuan, while “CNH” is the offshore version. China allowed central banks and other institutional investors access to its domestic market several years ago as part of a broad effort at balancing capital-flow pressures after a messy yuan devaluation in 2015 saw an exodus of money abroad.
Buying Chinese government bonds could leave the Trump administration in the potentially awkward position of being open to criticism that it was effectively financing its rival. Offshore, the supply of yuan assets is limited -- another consequence of China’s shift to a more conservative approach to internationalizing its currency in the wake of turmoil in 2015.
“There is the question of whether there are enough international renminbi assets available to purchase,” Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York, wrote in a note last week, using another term to refer to China’s currency.
The outstanding amount of CNH deposits globally is about 1.2 trillion yuan ($171 billion), according to JPMorgan. By comparison, that’s less than the stockpile of U.S. Treasuries held by Hong Kong, or slightly more than that owned by Taiwan.
Any intervention in the yuan by the U.S. “could provoke countermeasures from the Chinese that, in turn, increase the risk of unintended consequences,” JPMorgan’s Feroli wrote.
Trump’s continuing complaints about other nations’ weakening exchange rates had already stoked speculation about the potential for intervention before that drumbeat quickened Monday, when the Treasury Department officially designated China as a currency manipulator. China moved to ease pressures Tuesday with a stronger-than-expected daily fixing for the onshore yuan, a step that saw stocks recoup some recent losses.
Senior officials at the Chinese central bank also reassured foreign companies that the yuan won’t continue to weaken significantly. The offshore yuan took back a little less than a third of Monday’s loss on Tuesday. It was little changed at 7.0561 as of 8 a.m. in Tokyo Wednesday, down 2.6% for the year.
“I do think that risk has increased very sharply,” NatWest’s Mohi-uddin, who’s been following currency markets for more than two decades, said even after trading calmed somewhat Tuesday. “Financial markets seem to underplay the risk that if intervention occurs it won’t be very successful.”
A famous turning point for the dollar was the 1985 Plaza Accord, when the U.S. and key industrial-nation peers agreed to drive the greenback lower, and intervened in exchange markets to help make that happen. In 2000, the European Central Bank led rich countries in propping up the euro. While at the time the spot intervention was declared a failure, the euro did find a bottom not long after, Mohi-uddin said.
Taken together with U.S. monetary easing and the twin budget and current-account deficits, intervention could reshape the market narrative, against the dollar, according to Mohi-uddin.
Any U.S. intervention would presumably be unilateral this time around, as other nations haven’t expressed complaints about an excessively strong dollar. The Treasury is charged with setting dollar policy, while the Federal Reserve’s New York district bank executes intervention. Historically, the Fed has used its own assets alongside the Treasury in currency operations.
The Treasury has just under $95 billion in its Exchange Stabilization Fund, a special vehicle that dates back to the 1930s over which the Treasury Secretary has wide discretion. While that figure is small compared with the $5 trillion a day foreign-exchange market, its firepower would be enhanced with Fed backing and it could technically enlarge its arsenal through measures such as issuing bonds, analysts said.
The U.S. has only intervened three times since 1996: buying yen in 1998, euros in 2000, and selling yen in 2011 at Japan’s request. Before that, dating back to Plaza, it engaged in yen and deutsche mark operations, Treasury data show.
“The easiest intervention path is via euros and yen, hoping that other currencies strengthen via knock-on effects,” Steven Englander, global head of foreign-exchange research at Standard Chartered Bank in New York, concluded in a note to clients last month.
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