- China's yuan surged beyond the key psychological level of 7-per-US dollar Tuesday, reaching its strongest level in three months.
- The currency move arrives as trade tensions between the US and China cool from their summer highs.
- Though the 7-yuan-per-dollar threshold is largely arbitrary, China acknowledged its psychological importance in 2016 when it propped up its currency to avoid crossing that level.
- Traders around the world have been closely watching the yuan's strength as the two nations mull a "phase one" trade deal.
- Read more on Markets Insider.
China's currency surged below the key level of 7 yuan-per-US dollar on Tuesday, reaching its strongest level in three months.
The move comes as trade tensions calm from peak levels reached over the summer. The US and China are slated to sign a partial trade deal as soon as this month and bring a sign of progress toward ending the global conflict.
The White House is considering retracting some tariffs as well. Negotiators reportedly pushed the Trump administration to roll back duties on imports including toys, phones, and laptops before they go into place December 15.
"If all of this is accurate, the US has blinked," Markets.com chief analyst Neil Wilson said. "It seem that tariffs are hurting voters in some important states. And at a time of impeachment fears, Trump could do with a win on trade soon."
The yuan slide beyond the critical level in August as China geared up for further retaliation against US tariffs. The nation had previously adjusted the yuan's rate to stand below the psychological threshold, and markets tumbled on August 5 as the weakened currency forecasted new intensity in the trade war.
As US stocks tumbled, it became clear that the 7-yuan-per-dollar level was something to be reckoned with. With traders, economists, and central bankers alike now keenly focused on the currency, the People's Bank of China's daily fix — or where it pegs the yuan versus the dollar — has become the market equivalent of appointment viewing.
We further unpack below why the 7-per-dollar level is so significant, how a weaker yuan aids China, and why traders have become so transfixed by the foreign currency:
How does China set its currency's value?
The yuan, unlike other currencies, isn't freely traded. On a daily basis, the Chinese government fixes the rate of the yuan and then allows it to fluctuate as much as 2% within that set window.
While the yuan didn't move outside that 2% band Tuesday, the fact that it moved below 7 per dollar for the first time in three months reveals new levels of trade optimism from China's central bank.
China has been more aggressive with its currency in the past. It stepped outside its normal 2% band in August 2015 by weakening the yuan in three consecutive devaluations, cutting more than 3% off its value. The policy caused extreme market turmoil.
How does a weaker yuan help China?
Economists view a weakened yuan as a contingency against fallout from the US-China trade war, as it gives China an advantage in global trade.
When the yuan becomes cheaper compared with other currencies, Chinese goods become cheaper in other countries. This would counteract the tariffs set by President Donald Trump that are meant to punish China over allegations of intellectual-property theft and other issues.
It's not all good news for China. A cheaper yuan drives up the price of imports, risking inflation as the Chinese economy is already growing at its slowest rate in nearly three decades. It also motivates traders to turn away from the yuan and other Chinese assets as the weaker currency brings increased volatility.
What does the 7-per-dollar level represent?
Though the 7-yuan-per-dollar line is largely arbitrary and not set by any specific policy, China has set a precedent for keeping its currency stronger than that floor because of its psychological implications.
When the nation faced a sharp yuan depreciation in 2016, its government spent more than $107 billion of its foreign-currency reserves in a single month to keep the yuan stronger than the 7-per-dollar level.
The strategy boosted China's export business but led investors to move their funds out of the country's economy. It also prompted the US Treasury Department to accuse China of currency manipulation.
Other nations have long scolded the People's Bank of China for its influence on the yuan, accusing the country of weakening the currency whenever it needs a leg up in global trade.
The bank's governor countered such claims in August, saying the country "will remain committed to the market-based exchange rate regime, refrain from competitive devaluations, and will not target exchange rate for competitive purposes."
What does it mean to be labeled a "currency manipulator" by the US Treasury Department?
After the yuan fell below the critical level on August 5, the Trump administration officially named China a "currency manipulator." Though the designation is primarily symbolic, it did escalate the trade war by showing a united front from US officials against the Chinese government's decision.
The trade war raged on throughout the summer, but the weaker yuan sparked a so-called "currency war." Trump has repeatedly called for a weaker dollar, and a prolonged conflict could have prompted both countries to bring their respective currencies lower than before. There were even reports of the president looking to manipulate the dollar against the yuan to combat China's actions.
The yuan's return to past levels brings peace to one corner of the trade conflict and hints at an end to further tariff escalation.
Why does Wall Street care so much about the foreign currency?
With the US-China trade conflict pushing well into its second year, investors and analysts are desperate for a sign that the two countries will ink a deal.
The trade war is playing a massive role in slowing global growth and prompting rate cuts from central banks. Officials in Hong Kong cited the conflict as a reason for its economic recession, and Germany's manufacturing sector slumped as trade hurdles hit its key automotive industry.
The Federal Reserve issued three rate cuts over past months to boost the US economy amid trade uncertainties, but Fed chair Jerome Powell's latest statement hinted at a pause to future rate adjustments. With the US economy growing at a moderate pace, an end to the trade war would bring new fuel to the country's record-long expansion.
The 7-yuan-per-dollar level is just one part of the complex trade war, but the currency's Tuesday surge signaled to investors that, for now, the two nations are playing nicer than before.