U.S. Intervention Odds Rise as Yuan Plunge Fuels Trump’s FX Fury

(Bloomberg) -- People's Bank of China Governor Yi Gang says the nation won't use exchange rates as a tool in the escalating trade dispute with the U.S. But currency strategists say the Trump administration just might take that step.

The risk of a U.S. move to weaken the dollar has climbed in the eyes of some analysts after the yuan's plummet to a decade-low below 7 per dollar Monday prompted fresh criticism from U.S. President Donald Trump.

The U.S. leader decried the yuan's plunge as “currency manipulation” in a tweet and indicated he'd like the Federal Reserve to act to counter the move. The Chinese currency's tumble came days after Trump threatened to impose 10% tariffs on another $300 billion of Chinese imports.

Speculation is building among strategists that the yuan's sharp drop could push the administration to intervene in currency markets. While White House economic adviser Larry Kudlow said Friday that there are no plans for intervention, Trump has said he hasn't ruled out measures to counter the dollar's strength. If U.S. authorities do step in, it could sound the death knell of the strong-dollar policy that's been in place since the 1990s.

“Given that President Trump is reportedly willing to take action without following the guidance of his advisers, it doesn't seem like pushing such a policy through would be especially difficult,” said Shahab Jalinoos, global head of foreign-exchange trading strategy at Credit Suisse Group AG.

China's offshore yuan slumped as much as 1.9% to a record low of 7.1114 per dollar on Monday. The currency was 1.7% weaker in New York trading even after the assurances from the PBOC's Gang.

The U.S. last intervened in FX markets in 2011, along with international peers, after the yen soared in the wake of that year's devastating earthquake in Japan. That effort buoyed the dollar. Now, Trump's repeated complaints about the greenback's strength have analysts contemplating the wild-card notion that the U.S. could forcibly weaken the dollar -- a step not taken since 2000. That episode was part of a joint effort to bolster the euro.

Nomura sees a 20% probability that the U.S. intervenes in the next three months, analyst Jordan Rochester said in a Bloomberg Television interview Monday. He joins strategists from banks such as Barclays Plc, Goldman Sachs Group Inc. and Scotiabank in warning of a possible U.S. foray into currency markets.

Uphill Battle

However, the administration would face an uphill battle in trying to influence a market that generates over $5 trillion in daily turnover. The Treasury's Exchange Stabilization Fund holds almost $23 billion in greenbacks and around $50 billion in special drawing rights that it could convert. China, by comparison, holds about $3.1 trillion in currency reserves.

“In theory, the U.S. could intervene on the offshore yuan, but whether they could do so effectively if China was opposed is uncertain,” said Steven Englander, global head of FX research at Standard Chartered Bank. “The rates route via pressure on the Fed still looks to be the most promising path to dollar weakness.”

Traders ramped up Fed rate-cut bets Monday as global markets convulsed amid the heightened tensions.

Additionally, while the Fed has been an equal participant in the last three currency interventions, the central bank can opt not to contribute its own funds. Administration officials believe that for any move on the dollar to succeed, the Fed must agree with the policy and clearly communicate its support, according to people familiar with the matter.

See here for more reporting on Fed role in intervention.

The dollar has strengthened against most of its major peers this year as investors sought havens amid the trade war and slowing global growth. A gauge of the greenback has risen in five of the past six months, though it fell Monday along with increased expectations for lower U.S. borrowing costs.

Surging Yen

The risk of intervention also looms over the yen. Japan is keeping an eye on “nervous” moves in foreign-exchange markets following the threat of further U.S. tariffs on Chinese goods, and excessive moves aren't desirable, said Yoshiki Takeuchi, the top currency official at the Ministry of Finance.

The yen rallied to 105.79 to the dollar on Monday, the strongest since the so-called flash-crash in January. It has climbed about 2% in the past month, and the strength has prompted Japan's largest automaker, Toyota Motor Corp., to cut its profit outlook.

“I don't think the Bank of Japan will do nothing if this sort of activity carries on,” said Shyam Devani, senior technical strategist at Citigroup Inc. in Singapore. “The difficulty is at what stage will they do something.”

Not everyone is sure the moves on Monday herald the start of a global currency war.

“I don't think China is trying to devalue the yuan,” said Masahiro Ichikawa, a senior strategist at Sumitomo Mitsui DS Asset Management Co. in Tokyo. “We need to see whether the central bank will continue to set the yuan lower at its fixings in coming days.”

--With assistance from Subhadip Sircar, Michael G. Wilson, Charlotte Ryan and Nicholas Reynolds.

To contact the reporters on this story: Ruth Carson in Singapore at rliew6@bloomberg.net;Masaki Kondo in Tokyo at mkondo3@bloomberg.net;Katherine Greifeld in New York at kgreifeld@bloomberg.net

To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net, Liau Y-Sing, Mark Tannenbaum