Trade wars: Three reasons why the dollar is waving the white flag as China strikes back

The US Dollar has sunk after China announced launched its torpedo countermeasures in retaliation to the new US tariffs. So far, the ongoing negotiations provided hopes that it is just another crisis in the talks. The Chinese precision strike is already a significant escalation and a resumption of the outright trade war.

The crash in stock markets is normal given the clash between the world's largest economies. So does the rise of the Japanese yen, the No. 1 safe-haven.

But why is the greenback suffering a broader fall? The answer is related to China's new levies, but also on its other potential measures, stemming from a tweet by Hu Xijin, the editor-in-chief of the Global Times. His tweet read:

China may stop purchasing US agricultural products and energy, reduce Boeing orders and restrict US service trade with China. Many Chinese scholars are discussing the possibility of dumping US Treasuries and how to do it specifically.

And that already adds more bombshells against the battered USD that can be divided into three parts:

1) Tariffs take their toll

When the new tariffs come into effect on June 1st, US products will be less attractive for their Chinese consumers. This is the direct damage to the US economy, the tit-for-tat retaliation on the US tariffs.

A weaker US economy means a higher chance that the Fed will cut interest rates. 

2) Drop in direct Chinese consumption of US goods

If China indeed stops purchasing US agricultural, energy, services, and aircraft as the tweet claims, it would be a blow to farmers, energy companies, services companies, and Boeing, the latter already suffering from the recent crashes of its new jets. 

While it may be easier to strike deals with a country that controls its economy, failing to clinch an accord can be costly. 

As with the previous item, a weaker US economy means a higher chance the Fed Chair Jerome Powell and his colleagues will lose their patience and slash rates.

3) The bunker-busting bomb: selling treasuries

China holds around $1.13 trillion of US bonds as of February, which showed a third consecutive month of increases. The tweet muses about the dumping of US bonds. China would inflict damage upon itself if it massively sells off its vast holding of bonds. However, it may gradually reduce them. 

Demand for the safe-haven US bonds is high, but if a major holder such as China changes its policy, another significant actor may have to fill the gap and that would be the Fed. 

The central bank will stop reducing its balance sheet by the end of September, ending Quantitative Tightening. Considerable dumping of bonds by China may force the Fed to increase its balance sheet, or resuming net treasury buys last seen in October 2014. 

And if more greenbacks slosh around, their value falls.

Conclusion

The three-pronged retaliation by China raises the chances of Fed stimulus in three ways: tariffs, direct buying of US goods, and dumping US bonds, which may lead to the Fed stepping in not only with rate cuts but also with bond buys. 

All in all, there are good reasons to sell the USD.