World stock markets have plunged after a fall in the Chinese currency reignited the trade war between the US and Beijing and sparked concerns over the global economy.
President Trump has labelled China a “currency manipulator” for allowing the yuan to sink below 7 against the dollar, a decade low, raising the prospect of a currency war between the two nations.
While most global currencies are floating - determined by market forces - the Chinese government limits the yuan’s movement against the US dollar to a daily range of 2%. But a cheaper yuan makes its exports more competitive, especially as China battles to control the effect of trade tariffs imposed by the US. However, it also makes imports into China more expensive and puts a strain on the domestic economy, potentially pushing inflation up.
The Dow Jones dropped almost 3% to 25,700 amid fears of the effects of a ramping up in the trade war. Meanwhile, the FTSE 100 is down from 7,600 points to 7,200 points in a matter of days. China’s Shanghai Composite Index has fallen around 6% to 2,700 points in the first week of August, signalling a retreat from emerging markets. Shares in emerging markets-focused investment trusts have also fallen sharply.
George Efstathopoulos, multi-asset portfolio manager at Fidelity International, says a US intervention to weaken the dollar cannot be ruled out, particularly with Trump a vocal critic of the strong US dollar: “The chance of getting his way is surely higher now the Treasury has labelled China a currency manipulator and because the same department also has responsibility for setting US dollar policy.”
He believes the prospect of a US-China currency war has become more likely and this will lead to increased demand for safe havens such as the Japanese yen, gold and even the euro. Bitcoin prices have spiked in recent days too.
When trade war concerns were at their greatest in Q4 last year, Morningstar Investment Management’s Dan Kemp urged investors to tune out from the “noise” of volatile markets if they want to achieve their long-term goals: “When prices fall, we are typically far more focused on the loss to our existing capital than the opportunities to buy assets more cheaply.”
Tit-for-tat Devaluation
Fidelity's Efstathopoulos adds that China is likely to respond in kind to any US attempts to weaken its currency. The Chinese move to weaken the yuan was probably a deliberate response to the latest US tariffs on Chinese goods, argues Andy Rothman, investment strategist at Matthews Asia.
But China is unlikely to embark on full-scale devaluation, he argues as the latest tariffs are not having much of an impact on the Chinese economy: “China’s consumer story—the largest part of its economy—remains pretty healthy, as does employment and wage growth, so there is no reason for Xi to panic.”
Dr. Kerstin Braun, president of trade finance firm Stenn, argues that “Trump is playing games with global economies”. She says: "He lives and dies by the markets, and there’s a real worry Trump will try to tank the dollar in retaliation."
Throughout July, global market conditions had been benign, with the S&P 500, Dow Jones and Nasdaq all hitting record highs, fuelled in part by a strong earnings season, especially from the likes of tech giants such as Alphabet. While the trade war had not been fully resolved, a lack of flashpoints have kept market conditions stable in recent months.
Paul O’Connor, head of the multi-asset team at Janus Henderson, says that market volatility in recent days is a reminder of how sensitive investors are to negative news relating to trade. The latest round of US tariffs on Chinese goods is modest, he says, but the effect on sentiment is amplified because of wider concerns over the health of the global economy.
European investors have recession fears, not least because of the political uncertainty over Brexit and concerns over Germany, the eurozone’s largest economy. Sterling hit multi-year lows last week as the Bank of England warned that the prospect of a recession is about one-in-three, even if a Brexit deal is achieved.
