Financial markets are focused on the ongoing trade war between the US and China—which goods and services are in play and what measures are being taken or threatened in each case. But the trade conflict could spill over into currency markets—and that’s a risk that bears watching.

Currency has been a friction point and an undercurrent throughout the trade wars. The US administration has ratcheted up its criticism of China for manipulating its foreign-exchange (FX) rate in order to keep it weak and export friendly. Actually, China has been maintaining a stronger yuan these days—not a weaker currency. But the US is clearly growing more sensitive to currency moves.

That makes Monday’s decisive weakening in the yuan, a day that saw it move above seven per US dollar, a clear shot across the US bow. If currency tensions mount, the Trump administration could break with US practice and intervene to try to weaken the dollar. We think this action would disrupt financial markets and risk assets, broadening the trade war to other countries that would be hurt by a weaker dollar.

Currency markets are a zero-sum game: if the dollar is going to weaken, other currencies must strengthen. Much of the rest of the world is already on its back foot economically, so stronger currencies might be enough to push Europe and Japan into recession, and policymakers there would have to respond. Again, this possibility is still an “if,” but it’s a risk that needs to be monitored.

Currency Intervention Has Been Rare, but It’s on the Table

The ebb and flow of FX markets determines the value of the world’s currencies, but from time to time, policymakers step in to buy or sell their home currencies in an effort to influence their value—in essence, trying to overrule the market. Intervention used to be common, but it’s been very rare in developed markets since the mid-1990s. The US hasn’t targeted the dollar’s exchange value with intervention.

Currency intervention is rare because it’s not usually very effective. Currency markets are massive, and it isn’t clear that intervention can sustainably change a currency’s value. In addition, better global coordination among policymakers has led to widespread recognition that FX intervention is a beggar-thy-neighbor policy. If one currency gets stronger the others must get weaker, which may spur retaliation. If everyone intervenes, nobody gets anywhere—meanwhile, financial markets suffer.

Still, in our view, currency intervention by the US is now very much on the table. Presidential advisors have publicly indicated that it’s been a discussion point in the White House. That alone is extremely unusual—and it’s clear that the administration is very sensitive about FX rates.