The FX market instantly took notice of the escalation in rhetoric, with traders becoming alarmed that the new atmosphere of hostility between China and the US could mushroom into a full-blown trade war. Nevertheless, although Wen’s position on yuan revaluation suggests that Chinese policymakers are willing to jeopardise some diplomatic goodwill over the issue, I believe their reluctance is temporary.
The Chinese are unwilling to move on the issue of currency revaluation until they are absolutely certain that the US economy can join China as the second major pillar of global economic growth this year. Up to now, China has almost single-handedly jumpstarted the global economic recovery cycle through the massive fiscal stimulus programmes that helped fuel domestic-driven demand.
However, Chinese officials continue to be concerned over the fragility of the global recovery and are unlikely to make any meaningful adjustments to their currency policy until they are convinced that the US recovery is sustainable. In practical terms, this means that Chinese policy officials will not even consider making a move on revaluation until US labour markets show several months of positive job growth.
If China does revalue the yuan, then any appreciation will be gradual and is unlikely to exceed 5 per cent. Meanwhile, the US Treasury is set to release its annual report on international currency practices on 15 April. If it brands China as a currency manipulator, the dollar could falter against the yen as risk aversion flares up.
Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail email@example.com.