Expect dlr weakness if China named FX manipulator

LONDON, May 5 (Reuters) - If the U.S. Treasury deems China a
currency manipulator when it releases its foreign exchange
report next week, it could trigger more dollar weakness
especially against the yen.
Previous biannual reports have criticised China but stopped
short of formally labelling it a currency manipulator for
keeping its yuan cheap to gain an edge in international trade.
Analysts say the risk that China is given the tag has risen
dramatically since last month's G7 meeting of rich nations and
such a move would undermine an already vulnerable dollar by
raising the prospect of further yuan revaluation.
"There is a substantial risk that they do (call China a
manipulator)...I think the fact that China has allowed no
movement since the G7 meeting is quite important and there is a
risk that they are cited," said Chris Turner, head of FX
strategy at ING in London.
Group of Seven finance officials ratcheted up pressure on
Beijing to free up the yuan by singling out China in its
post-meeting statement as a country that needed more currency
flexibility to tackle its massive trade surplus.
The statement was taken by markets as a cue to sell the
dollar, which has fallen sharply against most major currencies
in the past three weeks, hitting a one-year low against the euro
and a 3-month low versus the yen .
Given Japan's trade ties with and proximity to China along
with a perception that Asian currencies have been kept
artificially low to compete with China, the yen is often traded
as a proxy for the yuan, also know as the renminbi.
Despite the escalation in international pressure, China has
let the yuan strengthen a mere 0.03 percent since the G7 meeting
on April 21 and the country's finance minister, Jin Renqing, has
said that China would not take orders from other countries on
correcting global imbalances.
"There's no question tensions are on the rise again and it's
finely balanced but I think the U.S. wants to give diplomacy a
further chance to work," said Simon Derrick, head of currency
research at Bank of New York. "If we don't see anything specific
from China over the summer then the October report looks more
likely."
China ditched its dollar peg on July 21 and revalued its
currency by 2.1 percent against the dollar but many U.S.
officials said this step did not go far enough. Since that
landmark revaluation, the yuan has risen a further 1.2 percent.

WHAT THEN?
If China is deemed a manipulator it could fuel U.S.
protectionist trade policies against China and trigger more
dollar weakness.
More than 50 measures to rein in China trade have been
proposed in recent months in Washington, where election-bound
lawmakers see the mushrooming U.S.-China trade gap -- which hit
a record $200 billion last year -- as a key issue with voters.
"The only way for the Chinese to then fight back and avoid
protectionism would be to substantially accelerate FX
appreciation," Goldman Sachs told clients in a note.
"Based on this logic, the knee-jerk market reaction to a
manipulation report naming China will likely be to buy all Asian
currencies against all other currencies."
As markets speculate about the outcome of the U.S. Treasury
report, ING recommends buying the yen against the dollar
with a short-term target of 112 and it expects the currency pair
to sink to 108 by summer.
The dollar was changing hands at 113.90 yen on Friday
morning.
Other analysts cautioned that if China was labelled a
manipulator it could prompt Beijing to dig in its heels and halt
all movement on the renminbi whatsoever, thereby dashing any
market hopes of a rally in Asian currencies.

PRE-EMPTIVE STRIKE?
Goldman Sachs said there were some expectations that China,
where financial markets have been closed for the week-long
Golden Week holiday since May 1, could make a pre-emptive move
and allow the yuan to strengthen significantly when markets
reopen on Monday.
Premiums on one-month non-deliverable forward rates for the
yuan , which gauge expectations for future
appreciation, are at their highest levels since the beginning of
the year.
UBS said it believed the U.S. Treasury will refrain from
giving China the manipulator tag, providing a short-term boost
to dollar/yen.
However, the bank reckons such an outcome could be the
result of a behind-the-scenes exchange for greater flexibility
in the dollar/yuan exchange rate by the Chinese authorities.
"In which case, a knee-jerk rally in dollar/yen should be
treated as an opportunity to establish fresh dollar/yen shorts,"
the bank said in a note to clients.