By Saumya Vaishampayan 

The yuan took its largest one-day tumble in two years Friday before recovering, the latest sign that investors are struggling to get a grip on the trade clash between the U.S. and China and the uncertainty it is creating in financial markets.

China's central bank set the yuan 0.9% lower against the dollar early Friday, the largest decline in the so-called daily fixing since 2016. The yuan's decline extended a three-month pullback, a shift drawing attention on Wall Street due to concerns that China could unsettle markets and inflame tensions if it chooses to sharply weaken its currency to help counteract tariffs.

But the yuan snapped back Friday, posting gains that left it up 0.2% against the dollar, after President Donald Trump lashed out at the strength of the U.S. currency and the Federal Reserve's plans to raise U.S. interest rates.

Investors said the latest remarks add to the growing unease in markets over the U.S.-China relationship. The standoff figures to increase volatility in foreign-exchange and interest-rate markets.

"Fermenting all this uncertainty certainly goes against the goals of the Trump administration," said Eswar Prasad, a trade professor at Cornell University. "It creates more uncertainty in the global trading environment, and all that uncertainty ends up...putting more upward pressure on the dollar."

At the heart of Mr. Trump's complaints is that the strength of the dollar helps other countries by making U.S. goods more expensive compared to China and European exports.

During a CNBC interview Thursday, Mr. Trump said the stronger dollar "puts us at a disadvantage." On Friday morning, he said on Twitter: "China, the European Union and others have been manipulating their currencies."

The remarks echo comments Mr. Trump and other administration officials have made on the strength of the dollar over the past two years. In January 2017, before Mr. Trump took office, he told The Wall Street Journal: "Our companies can't compete with [China] now because our currency is too strong. And it's killing us."

The unease comes even as policy and economic factors, rather than political threats, seem to be the main drivers of both the dollar and yuan.

In the past month, the yuan has fallen 4.5% against the dollar in mainland trading and 3.5% against a broader basket of its trading partners' currencies, according to a Wind Info index. The dollar, meanwhile, closed at its highest level in more than a year on Thursday before a 0.7% decline on Friday.

The yuan selloff has been spurred by signs of slowing growth that would argue for a weaker currency.

Meanwhile, the U.S. economy likely just wrapped up its strongest quarter of growth in years, encouraging the Federal Reserve to raise interest rates and helping drive up the value of the dollar.

"It is difficult to successfully weaken the dollar through jawboning," said Brad Setser, a senior fellow at the Council on Foreign Relations. "The administration is between a fiscal policy that supports a strong dollar and trade action that is pushing China to allow its currency to weaken."

Many analysts and investors say Beijing has been content to see the yuan weaken in line with market prices rather than actively depressing its value -- provided the moves aren't violent enough to spur panic. The central bank determines a daily exchange rate, known as the fix, based on the previous day's close and allows trading as much as 2% above or below that level in mainland China.

Yu Yongding, a former adviser to the PBOC, said Beijing was aware a weaker yuan would help the economy amid a potential trade war, but added: "The devaluation is the result of market forces."

Beijing, however, has previously been reluctant to let its currency depreciate too quickly. A modest devaluation in August 2015 sparked fears about a slowdown in the world's second-largest economy, sending global stock and commodity prices tumbling.

Authorities struggled to control subsequent capital outflows, burning through nearly $1 trillion in foreign-exchange reserves in 17 months to control the pace of depreciation.

During Asian trading hours Friday, China appeared to intervene in markets during to help support the currency, analysts said.

" Beijing is intending to send a signal to the U.S. with the recent [yuan] move. At the same time, there are potentially high costs associated with a currency war for Beijing," said Robin Brooks, chief economist at the Institute of International Finance.

"China has its own constraints, which are material and which -- in my opinion -- should prevent an all-out currency war," Mr. Brooks added

Write to Saumya Vaishampayan at saumya.vaishampayan@wsj.com

(END) Dow Jones Newswires

July 20, 2018 18:31 ET (22:31 GMT)

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