(Aug 12): US President Donald Trump has been hoisted by his own petard. He has been harmed by his own plan to harm someone else. Earlier this week, he declared China a currency manipulator at a time when he was desperate for China to actually be a currency manipulator.
Seems contradictory? Not really when the issues are pared to the essentials. The foundation of Trump’s tariff policy is for the renminbi to remain under the critical level of 7 to the US dollar. At these levels, the US tariffs inflict some real pain on Chinese exporters and so make Trump’s tariff policy more effective.
However, as most independent observers and analysts agree, the reasonable market-driven level for the renminbi is around 7.6. Some suggest 8. In a free market float of the renminbi, many suggest it would settle around the 7.6-to-7.8 level. Renminbi sentiment indicators all point to offshore pressure, not manipulation.
At 7.8 to the US dollar, the impacts of Trump’s tariffs would largely be negated from the Chinese exporters’ perspective and thus render a key platform of Trump’s policy almost ineffective.
For Trump’s tariff policy to succeed, he needed the People’s Bank of China to keep the currency under the critical 7 level. The success of his policy rested on China “manipulating” the renminbi to keep it under 7. The PBOC had “managed” the renminbi by setting a daily trading band. This was a partial free float of the renminbi and over time, many analysts expected the trading band to gradually widen and so ease the renminbi into a full convertibility. Left to its own devices, and not distracted by the trade war, the PBOC may have followed this path over the next 12 to 18 months.
By charging China with currency manipulation, Trump has opened the door to a much weaker renminbi with an unmanipulated exchange rate set by the market, rather than managed by the PBOC.
The PBOC sent a subtle — perhaps too subtle — message to the US several weeks ago when, one Monday, it “forgot” to set a trading band for the renminbi. The exchange rate quickly moved above 6.9 to the dollar before pulling back. We noted at the time that this was a clear warning to Trump of what would happen if the PBOC was forced to let market forces determine the value of the renminbi.
This week’s setting of the trade band above 7 is a clear warning of what is possible.
Rather than listening to the warning, Trump has fired the currency bomb. Now there remains only an appeal to Chinese goodwill when it comes to arresting the momentum of a move above 7 to the US dollar. The cost to the US is simply enormous. Already, Trump has committed US$44 billion ($61 billion) in subsidies to US farmers to counter the damage done by his trade war. To put that in perspective, US$44 billion is more than the total value of Australia’s agricultural exports.
A weaker unmanaged renminbi softens the tariff impact on Chinese exporters and makes US exports to China more expensive to Chinese consumers and industry.
The pressure for competitive devaluations across the region has now increased dramatically. Japan’s top currency diplomat warned that Tokyo was ready to intervene in the currency market if excessive yen gains threatened to hurt the export-reliant economy.
This is the most spectacular of the many own goals kicked by the US president and the collateral investment damage will be substantial in our region. As an early example, some US$60 billion was wiped off the value of Australia’s main share index in two days. Falls were led by mining stocks exposed to China. More investment destruction will follow across the region.
There are times when external fundamental factors are simply so powerful that they overwhelm technical and chart analysis of the market. This is one of those times. This has been described by Chinese President Xi Jinping as a grey rhino rather than a black swan. The potential was known, but the timing and development path were unknown.
However, technical and chart analysis helps the investor define the potential limits of the reaction. This analysis helps to define the conditions necessary for a change in the trend, so investors know when to enter the market again.
Technical outlook for the Shanghai market
The Shanghai Index gapped below the support level near 2,830. This was the lower edge of a broad trading band and represented the lower edge of the market oscillation around the 2,920 level. The upper edge of the trading band was near 3,040. This broad trading band provides the first method to estimate where the Shanghai Index may develop consolidation after this fall.
The width of the trading band is projected downwards and sets a target near 2,630.
The next step is to validate this target by assessing historical support and resistance levels. The historical support and resistance level is near 2,650. This level is not sharply defined. It acted as a clear support level in August and September 2018. The index clustered around this area as a resistance area in October to December 2018. It provided weak resistance when the index moved above this level in a new strong uptrend in February.
This suggests that the first downside support for the Shanghai Index is the area between 2,630 and 2,650. Investors will watch for consolidation activity to develop in this region. Consolidation activity includes a sideways movement as part of an L-shaped recovery. It includes a rally rebound and retreat pattern of behaviour associated with W-shaped recoveries. This level may provide the low point for a V-shaped recovery. It is far too early to know how this will develop but there is a high probability that any trend recovery will develop from near the 2,630-to-2,650 level.
Looking further into the future, there are two features that will help define any new uptrend. The first is resistance near 2,830. This was a strong support feature from May to July. It will probably be a strong resistance feature for any new uptrend. The second feature is the value of the downtrend line A. This will provide the first resistance feature for any new uptrend.
The Shanghai Index is being buffeted by external forces, but these do not change the essential structure of support and resistance levels in the market.
Daryl Guppy is an international financial technical analysis expert and special consultant to AxiCorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for more than a decade. Guppy appears regularly on CNBC Asia and is known as ‘The Chart Man’. He is a national board member of the Australia China Business Council.
