Andrew Robinson, FX Analyst, Saxo Capital Markets
China - Mission Accomplished?
The timing of the announcement from China that it was to revert to a managed float of its currency was a welcome surprise to markets, but has failed to really ignite a confident, bullish rally in risk and associated markets. The question is, why?
In the aftermath of last weekend’s developments, initial analysis suggested that the plan was caged in vague terms and offered neither an absolute commitment, nor a definite timescale for any adjustments. Indeed there were suggestions the announcement was intentioned to deflect pressure ahead of the G20 meeting this weekend and the pending July 15 US report on currency manipulation.
In the aftermath of last weekend’s developments, initial analysis suggested that the plan was caged in vague terms and offered neither an absolute commitment, nor a definite timescale for any adjustments. Indeed there were suggestions the announcement was intentioned to deflect pressure ahead of the G20 meeting this weekend and the pending July 15 US report on currency manipulation.
Market Reaction
From the outset on Monday morning, markets were prepped, poised and positioned for a strong rally in risk with equity markets opening higher, commodity currencies surging and adventurous year-end CNY levels being discussed. The jolt came when the morning CNY fix by the PBOC was kept at Friday’s levels (6.8275) and traders had to re-think as markets reversed. Indeed, by the end of the day most currencies had given back all of the euphoric gains. Was this a case of the PBOC wanting to control markets? Ie prevent traders having the “guaranteed trade” or the one-way bet? Or was merely a question of market mechanics? Tuesday perhaps gave a bit more clarity with the USDCNY fixed almost 0.5% lower (coincidentally the maximum allowed under current policies) and risk was given another (albeit short-term fillip).
From the outset on Monday morning, markets were prepped, poised and positioned for a strong rally in risk with equity markets opening higher, commodity currencies surging and adventurous year-end CNY levels being discussed. The jolt came when the morning CNY fix by the PBOC was kept at Friday’s levels (6.8275) and traders had to re-think as markets reversed. Indeed, by the end of the day most currencies had given back all of the euphoric gains. Was this a case of the PBOC wanting to control markets? Ie prevent traders having the “guaranteed trade” or the one-way bet? Or was merely a question of market mechanics? Tuesday perhaps gave a bit more clarity with the USDCNY fixed almost 0.5% lower (coincidentally the maximum allowed under current policies) and risk was given another (albeit short-term fillip).
Market Outlook
With the first “revaluation” under our belts, do we have a longer-term trend in place or just a short-term “placating” fix? The forward market is currently pricing in less than 2.5% further appreciation for the coming 12 months. That latter forecast could move to as high as 5% if the market looks for the rate of appreciation formerly established for the crawling peg in the 2005-2007 period. It is certain that we are in a phase of gradual revaluation with the G-20 meeting this weekend and the July 15 deadline major milestones. The announcement from the Chinese seemed as pains to remind that the “flexibility” could go either way (ie a CNY devaluation along the way is not out of the question). A higher fix within an established downtrend would not necessarily mean a reversal in trend, merely the PBOC attempting to smooth “unwanted volatility”.
With the first “revaluation” under our belts, do we have a longer-term trend in place or just a short-term “placating” fix? The forward market is currently pricing in less than 2.5% further appreciation for the coming 12 months. That latter forecast could move to as high as 5% if the market looks for the rate of appreciation formerly established for the crawling peg in the 2005-2007 period. It is certain that we are in a phase of gradual revaluation with the G-20 meeting this weekend and the July 15 deadline major milestones. The announcement from the Chinese seemed as pains to remind that the “flexibility” could go either way (ie a CNY devaluation along the way is not out of the question). A higher fix within an established downtrend would not necessarily mean a reversal in trend, merely the PBOC attempting to smooth “unwanted volatility”.
Macro Implications
It will be important to see how much of the criticism China will have blunted with this weekend's move. The very weak Euro of the last six months has taken plenty of pressure off the European side of the equation - they actually had the most reason to criticize China previously. But what about the US as it approaches mid-term elections and is looking for a scapegoat for its economic ills? Certainly one would expect some of the wind being taken out of the sails of US Congress and their drift towards protectionist policies. But how long will it take before the US import lobby goes to Congress moaning about imported inflation? Let’s have our cake and eat it!
It will be important to see how much of the criticism China will have blunted with this weekend's move. The very weak Euro of the last six months has taken plenty of pressure off the European side of the equation - they actually had the most reason to criticize China previously. But what about the US as it approaches mid-term elections and is looking for a scapegoat for its economic ills? Certainly one would expect some of the wind being taken out of the sails of US Congress and their drift towards protectionist policies. But how long will it take before the US import lobby goes to Congress moaning about imported inflation? Let’s have our cake and eat it!
However, the fact that China chose to revert to its managed float (they have reiterated ad nauseum that such a move would only happen when China deemed it to be in it s own best interest) suggests that they feel more comfortable with a shift in its economy to a more domestic-focused one from the export-driven one previously. But what about the Chinese exporters who are seeing the value of their returns diminishing? The Chinese Ministry of Commerce also said it would monitor the implications for exporters but likely has no power to react. Or would a pickup in domestic demand be enough to offset lower export returns? This is more of a longer-term issue and something that data will confirm or refute along the way. Implications for growth? At this juncture we would suggest minimal, though that would be dependent on domestic consumption.
From here?
Generally we would view the developments as constructive and once the “noise” of the initial to-and-fro in markets has died down we should see more support into the risk appetite scenario. We expect USDCNY to resolve lower in coming months (but not a one-way street), preferring a move closer to 2.5% rather than 5% over the next 12 months. The down-move will likely drag other USD/Asia currency pairs along with it and invoke further FX intervention from Asia Ex-Japan central banks to slow the appreciation of their own currencies.
Generally we would view the developments as constructive and once the “noise” of the initial to-and-fro in markets has died down we should see more support into the risk appetite scenario. We expect USDCNY to resolve lower in coming months (but not a one-way street), preferring a move closer to 2.5% rather than 5% over the next 12 months. The down-move will likely drag other USD/Asia currency pairs along with it and invoke further FX intervention from Asia Ex-Japan central banks to slow the appreciation of their own currencies.
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