The yuan may weaken beyond 7.5 against the U.S. dollar if President Donald Trump kicks tariffs up to 25% on the recently threatened $300 billion of Chinese goods, says Bank of America Merrill Lynch.
China's currency has gotten greater attention in recent days after Beijing allowed the yuan to weaken past the important psychological level of 7 per dollar for the first time since the global financial crisis.
That depreciation came after Trump threatened to slap 10% tariff on $300 billion of Chinese goods starting Sept. 1. If that goes ahead, the U.S. dollar-Chinese yuan exchange rate may touch 7.3 by the end of 2019, weaker than an earlier forecast of 6.63, the BofAML predicted.
If that tariff rate increases to 25%, "you'll be looking at CNY beyond 7.5 levels" assuming existing economic and financial conditions don't change, Rohit Garg, a currency and rates strategist at the bank, said Wednesday.
China's move tells you that the U.S. doesn't have all the balls in this game, the Chinese can mess up this dollar weakening desire of Donald Trump very easily.Taimur Baigchief economist, DBS
Many analysts have said they expect Trump to hike tariffs on all Chinese goods to 25% after the recent escalation in the U.S.-China fight. Such an elevated tariff rate would hurt sentiment further and the U.S. Federal Reserve would likely step in to stem some negativity, Garg told CNBC's "Squawk Box."
The Fed "would sound more dovish, it would actually go ahead and cut rates," he said. That means it may be "difficult for the dollar to actually rally as much," he added.
Washington has already applied a 25% tariff on $250 billion of Chinese goods and labeled China a currency manipulator as the two economic giants battle in areas of trade, technology and now foreign exchange. For its part, Beijing imposed elevated tariffs on billions of dollars of U.S. goods and said it will stop buying American agriculture products.
US dollar strength
The U.S. has for years accused China of keeping the yuan artificially low to gain advantage in trade — an issue Trump has been complaining about since he became president. Last month, Trump suggested the U.S. should "MATCH" the "big currency manipulation game" taken by China and Europe.
But by ratcheting up rhetoric and tariffs against China, Trump has caused the U.S. dollar to strengthen even more compared to the yuan and other currencies, said Taimur Baig, chief economist at Singaporean bank DBS.
The U.S. dollar index — which measures the greenback against a basket of six currencies — has risen by around 1.4% this year.
"That's the irony of it all: The more grenades Donald Trump throws to give the U.S. a competitive advantage, the more risk off we see and more safe haven flows go into the U.S. and Treasury rallies and the dollar remains strong," he told CNBC's "Squawk Box" on Wednesday.
The Fed lowering interest rates or Washington intervening in the currency markets could help to contain the greenback's strength, but both options "will have far less impact on the dollar than just the end of the trade war," said Baig.
"If there were some sort of resolution that the actions between the Chinese and Americans will lead to a smaller surplus between the U.S. and China, to me, that would be the most powerful driver of a weaker dollar," he said.
"But that is not at all the way the narrative is playing out right now," he added. "China's move tells you that the U.S. doesn't have all the balls in this game, the Chinese can mess up this dollar weakening desire of Donald Trump very easily."