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The Dollar-Yuan Exchange Rate is a Very Poor Trade Candidate for Trade Wars

The Dollar-Yuan Exchange Rate is a Very Poor Trade Candidate for Trade Wars

John Kicklighter, Chief Strategist

Talking Points:

  • Trade wars are a critical fundamental theme that will likely motivate much of the volatility and momentum in the near future
  • While it is essential to account for this global stand off - and even take advantage - the Dollar-Yuan is a poor outlet
  • Being so close to the heart of trade wars, a conduit for remarkably uncertainty and presumed intervention makes USDCNH a risk

See how retail traders are positioning in USDJPY, other FX crosses, indices, gold and oil intraday using the DailyFX speculative positioning data on the DailyFX sentiment page.

An Appetite to 'Take Advantage of' Trade Wars

One of the first axioms for fundamental trading is to identify the most pervasive themes so that we are better able to circumvent the risks or to position in order to take advantage. There is little doubt that one of the most persistent headlines nowadays is the surprise and destructive course of trade wars. There are many fronts to this broad theme lately, but the most recognizable is the rapid escalation in tension between the United States and China. From US-driven metals' tariffs to reciprocal $50 billion intellectual property duties to the threat of a further $200 billion in taxes against China by the aggrieved United States. The tab seems to keep growing alongside the potential fundamental fallout. Naturally, if you want to be better capable of navigating these markets, staying on top of the US-China trade war is a key. Yet, utilizing USDCNH to take advantage of such a systemic threat is not a particularly sound idea.

The Dollar-Yuan Exchange Rate is a Very Poor Trade Candidate for Trade Wars

The Problem with US vs China

It is important to recognize that trade wars is a catalyst and not the ultimate fundamental 'ends'. Though otherwise pervasive, the economic escalation in trade restrictions is a burden to global growth and investor sentiment which threatens to tap underlying risk trends. Therefore, the crucial theme is global investor sentiment itself - a broad and all-consuming interest that can override all other matters. In the hierarchy of what can draw our attention to the stretch in value and the potential for instability, however, there are few other factors that can tip the scales as readily as this steady escalation in trade retaliations. Yet, if we are attempting to follow this direct engagement as a means to navigate a safe course from risk or take advantage of the capital changes that result; we should consider some exceptional caveats in this unmoored theme. One issue is establishing which country has more to lose as conditions escalate. At this stage, China is still considered the loser as this stand off builds as the primary exporter. This is further the case considering the country is attempting to make a transition from a command economy to a more open-market alternative to solidify its position in the global scheme. This is a very troubling turn of events.

The Dollar-Yuan Exchange Rate is a Very Poor Trade Candidate for Trade Wars

The Problem with the Dollar vs Yuan

While we can currently still separate the Dollar as the safe haven and the Yuan as the at-risk currency in this pairing, this convention may not always hold. Eventually, if the United States continues pushing trade wars on multiple fronts, the risk of a global reprisal may ultimately lead the risk back to the doorstep of US markets and its currency. That is not to say the Chinese currency will take on the mantle of a safe haven - as it does not have the proper qualities - which is an even greater complication. Evaluating market movement between two fundamentally weakened currencies is a lower probability endeavor than pairing an outright strong currency versus a weak one. Further complication come in the form of question over the veracity of Chinese data which was reiterated by the 2Q GDP figures from China alongside key growth measures for June. This makes it difficult to assess the exact impact need for response.

If Not USDCNH, Then What?

Without doubt, the most troubling issue when it comes to dealing with USDCNH as the preferred vehicle for trading trade wars and their consequences is the potential for manipulation. It is common and well-founded concern that Chinese authorities are exerting influence over their capital markets and the exchange rate in an effort to quell destructive instability. That effort may not always prove sustainable and effective, but it can create significant distortion. Ultimately, it creates a troubling trade environment. So, if USDCNH is not a viable option, where should we look? If you want direct impact to trade wars, pursuing Dollar to its course of a net fall out further down the line is viable if set against other counterparts. If you want to avoid the uncertainties of President Trump's instigation, looking to China trade dependent economies like Australia and New Zealand can prove meaningful outlets - just not against the US Dollar. And if you want a systemic haven given the distortions, gold is a unique alternative to a troubled Greenback. We focus on trade-wars and USDCNH in today's Quick Take Video.

The Dollar-Yuan Exchange Rate is a Very Poor Trade Candidate for Trade Wars

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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