The rise of the dollar since the 2016 US election has been a significant factor in global markets, but its gains are not being driven by market expectations of increased tariffs. The dollar has risen against major currencies like the euro and British pound, but has shown limited appreciation against the yuan and Japanese yen, which would be most impacted by Chinese tariffs. This suggests that markets currently price little tariff risk.
China’s response to further US tariffs is expected to involve depreciation of its currency as an offset. However, China’s leadership may be averse to allowing the yuan to fall substantially due to concerns about capital flight and maintaining stability. Proponents of a large yuan depreciation point to past instances of capital flight in 2015/6, but there are currently no signs of significant resident outflows.
The incoming US administration may try to preempt a large yuan depreciation by imposing sector-specific tariffs or phasing in universal tariffs with performance benchmarks. Regardless, market expectations suggest that the coming months will be volatile as markets price little tariff risk. With the dollar’s gains not being driven by tariff-related factors and China’s leadership potentially holding back on significant currency devaluation, it remains to be seen how markets will respond to further US-China trade tensions.
Source: https://www.brookings.edu/articles/china-tariffs-and-trump-2-0