Will the RBNZ Cut Rates? Implications of China Currency Manipulator Label

The US government looked the other way for the past 25 years but under President Trump’s watch that is no longer be the case. For the first time since 1994, the US Treasury labeled China a currency manipulator. China responded by denying “any use of the exchange rate as a tool to deal with trade disputes” and blasted the US for taking action that would “severely damage international financial order and cause chaos in financial markets.” But instead of tanking, the Dow Jones Industrial Average stemmed its slide and the Chinese Yuan stabilized. In other words chaos did not rain down after the US announcement. Everyone will agree that the currency manipulator label has more symbolic than economic implications. It fulfills 2016 Trump’s campaign promise to slap China with the label and mandates the Treasury to “take action to initiate negotiations” and work with the IMF to remedy the problem. If no agreement is reached, the US can impose further penalties and restrict US government business with China.

Lets be clear though, while the Chinese Yuan dropped to its lowest level earlier on Monday and its no secret that China “manages” its currency, they meet only one of the three criteria’s previously set by the Treasury to declare a country a currency manipulator. The three part tests requires a major trade surplus with the US, a significant current account surplus with the rest of the world and persistent currency intervention. While China’s trade surplus with the US is large, its global current account surplus accounts for only 0.4% of its GDP. As for the currency, it is more likely they are allowing the Yuan to weaken rather than actively intervening to devalue it. Regardless, the market’s worst fears continue to be realized and this action will push China harder.

So as we wrote in Monday’s note, stocks, USD/JPY and other major currencies have more room to fall. Today is nothing more than a pause before further selling. Everything coming out of China tells us that they are gearing up for a bigger response that will intensify rather than deescalate trade tensions.

Better than expected economic data combined with a less dovish Reserve Bank of Australia also contributed to today’s rallies. In Germany, factory orders rose 2.5% against a forecast of 0.5%. In New Zealand, the unemployment rate dropped to an 11 year low of 3.9% from 4.2% as wages surged. Australia’s trade surplus also increased but most importantly, the RBA did not ratchet up dovishness in response to the tariffs. Instead they said they will ease further if needed but “growth is expected to strengthen gradually from here.”

The Reserve Bank of New Zealand on the other hand is expected to lower interest rates. The last time they cut was in May and when they met in June they said “lower interest rates may be needed given the downside risks.” They were worried about the global outlook, domestic demand, house prices and business investment. Taking a look at these same measures, spending has weakened since the last month, house prices fell further, the global outlook deteriorated significantly and with the new tariffs business investment is likely to contract further as business confidence falls to a 1 year low. The arguments are there for a rate cut and based on the decline in NZD/USD investors have priced the move in. So the main question is whether the RBNZ sees the need to take interest rates down to 1% later this year. We think they will no choice but to leave the door open to more easing but the language of their monetary policy statement will give us a better sense of how close they are to lowering rates again. The key level to watch in NZD/USD is .6450