With the 2024 US presidential election on November 5, Donald Trump has made a strong comeback. During Trump 1.0, particularly in 2018 and 2019, the escalating trade frictions between China and the US caused the RMB to depreciate by more than 10% against the US dollar. During the election, Trump threatened to impose a 60% tariff on all imports from China, sparking market concerns about the possibility of another round of downward pressure on the RMB. This article intends to explore this issue.

 

Recent exchange rate adjustments are not entirely due to concerns about China-US trade prospects

As of November 22 the onshore RMB central parity rate was 7.1942, down 1.3% from November 5; the onshore spot rate (the exchange rate in China's interbank foreign exchange market at 4:30 p.m) was 7.2452, down 1.9%; and the offshore RMB exchange rate (CNH) was 7.2597, down 2.2%. This has been interpreted as reflecting market concerns that Trump 2.0 could resume tariff sanctions against China, exacerbating negative impacts on China's foreign trade exports and economic prospects. However, this may not be the whole story.

 

The other half of the story is that, with the finalization of the US election results, the "Trump trade" that had been partially unwound before the election has now resurfaced. This is because the market generally expects that with Trump's return to the White House, he will implement tax cuts and deregulation policies, which will boost the US economy, increase US inflation resilience, and reduce the Federal Reserve's room to lower interest rates.

 

As a result, the market has further reassessed expectations for the Federal Reserve's easing, leading to a new round of rapid increases in US Treasury yields and the US dollar index. As of November 22, the 10-year Treasury yield was 4.41%, up 15 basis points from November 5; the US Dollar Index (DXY) was 107.49, up 3.9%, reaching a new high for the year.

 

During this period, most non-US currencies weakened against the US dollar. The decline in the RMB exchange rate was not among the top, with the CFETS RMB Index at 100.06, up 0.5% from November 8.

 

In the recent rebound of the U.S. dollar index and the corresponding retreat of the Chinese yuan, the central parity rate of the RMB has exhibited increased elasticity compared to the first half of the year. During periods of facing downward pressure in the first half of the year, the central parity rate fluctuated narrowly around 7.10, but it has now quickly adjusted to around 7.20, reaching new lows for the year multiple times since November 7.

 

Simultaneously, the deviation between the onshore exchange rate and the central parity rate has narrowed significantly. In the first half of the year, the exchange rate typically deviated from the central parity rate in a weakening direction, with deviations often exceeding 1%, and approaching the 2% limit on certain trading days. Currently, the exchange rate fluctuates around the central parity rate, with positive and negative deviations within 1%. This reflects that since the end of September, as a series of incremental fiscal and monetary policies in China gradually implemented and took effect, China's economic recovery prospects have improved, to some extent counteracting the impact of negative external factors.

 

Direct and indirect impacts of Trump tariffs on the RMB exchange rate

During his election campaign, Trump mentioned escalating trade frictions with China in four aspects. First, revoking China's Permanent Normal Trade Relations (PNTR, i.e., Most Favored Nation (MFN)). Second, imposing a tariff of 60% or higher on all Chinese exports to the US. Third, phasing out imports of necessity goods from China within four years. Fourth, cracking down on Chinese goods exported to the US through third countries.

 

This will, through trade and investment, directly affect the supply and demand relationship in the foreign exchange market, thereby influencing the trend of the RMB exchange rate.

 

There are two indirect impacts: one is through financial market and confidence, affecting market expectations, thus influencing the RMB exchange rate trend. Tensions in China-US trade relations are negative for the RMB, while any de-escalation is positive for the RMB. The other is through Trump tariffs, affecting the US inflation trend, thus influencing the Federal Reserve's monetary policy path. If US inflation remains high or even experiences secondary inflation, the Federal Reserve could slow or halt interest rate cuts, or even resume interest rate hikes. If the Federal Reserve's easing is less than expected, it could push the US dollar stronger, reapplying pressure on non-US currencies, including the RMB.

 

Comprehensive policy measures to actively respond to the impact of Trump 2.0 on the RMB exchange rate

According to the US Bureau of Economic Analysis (BEA), in 1986 (the year following the Plaza Accord in September 1985), Japan accounted for 22.2% of U.S. goods imports, exceeding China's historical peak share of 21.4% in 2017; by 2023, Japan’s share had dropped to just 4.7%, and further decreased to 4.5% in the first three quarters of 2024. In 1991, Japan accounted for 56.4% of the US goods trade deficit, making a historic high; by 2023, this share had fallen to just 6.7%, and further dropped to 5.7% in the first three quarters of 2024.

 

Judging from these indicators, the current China-US trade decoupling appears to be even more pronounced than the previous Japan-US trade decoupling. From 2018, when Trump 1.0 initiated the China-US trade conflicts, to the three years of the Biden administration in 2023, over the span of six years, China's share in US goods imports decreased by 7.7 percentage points and its share of the US goods trade deficit dropped by 20.7 percentage points. In contrast, during the Japan-US trade tensions from 1987 to 1992, Japan's share of imports of goods fell by 4.1 percentage points but rose by 13.3 percentage points in the merchandise trade deficit. By 2023, China's share in US goods imports had fallen to 13.7%, and further to 13.2% in the first three quarters of 2024. China's share in the US goods trade deficit was 26.2% and 24.7%, respectively.

 

Obviously, in the context of China's economy being significantly dependent on external demand, the negative impacts that Trump tariffs may trigger cannot be underestimated. This is precisely an important manifestation of the increasingly complex and challenging external environment facing China's economy, with increasing uncertainties and instability.

 

In recent years, China's importance in the US trade imbalance has declined drastically, while domestic inflationary pressures in the US have also been considerable. Therefore, Trump 2.0 may not have a strong incentive to immediately or fully implement his tariff threats.

 

The premise is that China should focus on its own internal affairs, accelerate the implementation of stock and incremental policies, further comprehensively deepen reforms and opening up, push the economy back to a reasonable range, and reverse market expectations and boost market confidence. This is crucial for China to respond to various external shocks. Furthermore, China must ensure that adequate follow-up and dynamic evaluation mechanisms are in place to assess the potential impact of Trump 2.0's trade policy on China. By implementing scenario simulations, taking proactive measures, and planning ahead, China can minimize risks and maximize opportunities for potential adverse outcomes.

 

On the other hand, it is not advisable to exaggerate the impact of Trump’s tariffs on the RMB exchange rate. The previous significant impact of China-US trade disputes on the RMB was mainly due to Trump’s sudden decision to instigate a China-US economic decoupling and technology competition. It is not surprising that the exchange rate overshooting occurred in the process of repricing this major risk event that exceeded expectations. In fact, by the later stages of Trump 1.0, his extreme pressure on China had become somewhat monotonous, and the foreign exchange market had blunted its response. Throughout his tenure, the Biden administration has pursued a strategy of "investment, alliances, and competition" against the Chinese economy. This included the construction of "small courtyard and high wall" and the promotion of "decoupling and breaking chains". Despite these efforts, the foreign exchange market remained largely unaffected.

 

If Trump 2.0 were to engage in aggressive economic pressure tactics against China, it could once again draw market attention and instigate turbulence in the foreign exchange market. However, this is more likely to be event-driven. Flexibility of the RMB exchange rate plays a crucial role in containing the impact of such external pressure. A two-way fluctuation in the RMB exchange rate, with enough flexibility, allows it act as a "shock absorber" to absorb both internal and external shocks. Meanwhile, China should also prepare contingent plans based on scenario analysis and stress tests, implement comprehensive measures, strengthen guidance on expectations, prevent the formation of unilateral consensus expectations and their self-fulfillment, and firmly guard against the risk of exchange rate overshoot.

 

GUAN Tao is the Global Chief Economist at BOCI China