The global trade war has morphed into a currency war. Here's why that's a scary proposition for markets.
- The trade war has increasingly become focused on currencies, with the recent spat with China over the yuan in the spotlight.
- The Chinese currency's fluctuation spelled disaster for global equities. Then, when China fixed the yuan higher than where experts expected, markets rebounded.
- The volatility will likely continue if currency remains in the forefront of the global dispute, but could do long term damage on the global economy.
- Read more on Markets Insider.
President Donald Trump's trade war has increasingly revolved around the role of global currencies.
It's a shift he's ushered along by crying foul on alleged currency manipulation. And there have even been reports that he's considered doing it with the US dollar.
Now, amid an ongoing spat with China, the currency war is again front-and-center as the global trade dispute rages. It ultimately amounts to a race to the bottom as countries try to push the value of their currencies lower than competitors in order to gain an advantage in trade. This is also why Trump has said he wants a weaker US dollar.
This runs counter to how countries are supposed to work together in order to achieve a balanced economy. When cooperation breaks down, global markets feel the negative effects. That's exactly what's played out around the world over a series of months - and experts are getting increasingly worried that there's no end in sight.
"The market is going to be very volatile," Dan Ikenson, director of the Herbert A. Stiefel Center for Trade Policy Studies at the Cato Institute told Markets Insider. "A trade war that was supposed to be easy to win seems like it's going to be hanging around for a long time."
The immediate damage a currency war can inflict has been clear in recent days. US equities slid to their worst performance of 2019 Monday - erasing billions of dollars in wealth - when China let the yuan fall below a key psychological threshold. The plunge also marked the currency's lowest level since 2008.
Meanwhile, the Cboe Volatility Index - or VIX, commonly known as the stock market's fear gauge - jumped 32% in a single day. The weakness also extended into major European and Asian indexes. Sharp fluctuations also struck the bond market as 10-year Treasury yields plummeted, pushing the yield curve - a closely watched recession indicator - to its most inverted level since 2007.
Then, on Tuesday, markets stabilized when the People's Bank of China set the daily yuan rate higher than expected and said it did not manipulate the currency after a formal accusation from the US Treasury Department.
The two-day takeaway is clear: currency shenanigans are going to negatively impact market sentiment. And considering the matter is largely unresolved, it's likely that there will be much more volatility in the currency market that finds its way into other asset classes. Many - including Trump - now think the ordeal could last until 2020.
"The markets now are going to be hanging on everything that's stated on trade negotiations," so there will be fluctuations depending on signs of progress, Dom Catrambone, CEO of Whitford Asset Management told Markets Insider. "Now I think people need to be watching their portfolios."
Further, China isn't the only global power Trump has fought. The President also accused his European counterparts of manipulating their currency when the European Central Bank suggested in June it may lower interest rates and purchase another round of assets to offset a slowing economy.
Trump did cool European tensions slightly when he made a deal to increase US beef exports to the EU - a move also designed to support American farmers that are hurt by the China tariffs. But even when announcing the agreement, he spooked European officials when he made a joke about levying tariffs on cars from Europe.
While currency devaluation seems to be the latest bargaining chip in the global trade dispute, the long term impacts of weaker currencies in the US and abroad could be "really bad," Catrambone said.
After all, a strong currency tends to be good for both consumers and consumption. And Ikenson thinks prolonged weakness in the greenback could usher in the next big economic collapse.
"A weaker currency could be inflationary and recessionary" over time, he said.
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