China’s Currency Weakness: Not as Bad as it Seems—Yet

China’s currency depreciated this week, with the exchange rate rising to more than 7.0 renminbi per US dollar, unnerving investors worldwide. Here’s the good news: we don’t think the decline is as worrisome as it may seem.

There’s no doubt that currency has been a friction point throughout the US-China trade war, and recent events have stoked fears that the trade war is at risk of turning into a currency war. As my colleague, Eric Winograd noted, the US administration is growing more sensitive to currency moves.

The 7.0 renminbi per dollar level was psychologically important for traders; until this week, the Chinese renminbi hadn’t been weaker in more than a decade.

But the real impact of this move seems less troubling to us. With the US threatening to slap a 10% tariff on another $300 billion of Chinese imports next month, a weaker renminbi is to be expected. In fact, we think the dollar could rise bumpily toward 7.2 renminbi as the countries struggle to strike a deal to avoid the tariffs.

In the meantime, we would expect short sellers to test the exchange rate should it move back below the 7.0 level before any deal on trade is reached.

Currency Depreciation Is Overdue

Keep in mind that the renminbi has depreciated against the US dollar by just 0.53% so far this year—far less than other currencies, such as the South Korean won, that are being affected by the US-China trade war. In fact, the renminbi’s fluctuations have been much less pronounced this year than the euro’s or the British pound’s.

We wouldn’t expect the exchange rate to exceed 7.5 renminbi—and getting to that level would likely be a drawn-out process. However, if trade negotiations end unsuccessfully and the US moves to raise tariffs to 25% on all $500 billion of Chinese goods, the currency could head in that direction.