Whither The Yuan

A little over three months ago, I warned investors not to forget about the Chinese yuan.

The period of subdued dollar strength that followed the Shanghai Accord in February and the Fed’s decision to keep rates on hold at its March meeting allowed Beijing to go ahead with its unstated policy of weakening the trade-weighted yuan while gently (and that’s key) guiding the CNY lower against the dollar.

After all, if you’ve got a quasi peg as China does, and if your economy is export-driven, just about the last thing you need is for the currency to which your currency is pegged to strengthen. If it does, the goods you export will become more expensive on the world market and your economy will suffer. That’s why China devalued the RMB in the first place and it’s also why they adopted the trade-weighted index as a reference point last December. Here’s a bit of visual history via Goldman, followed by some commentary:

cny

We often encounter the view that the RMB is asymmetric, by which people mean that the currency weakens when the Dollar appreciates, but doesn’t commensurately strengthen when the greenback weakens. Intuitively, the fact that the CFETS basket has fallen around 10 percent while the Dollar has been stuck in a range means that this is true almost by definition (Exhibit 1). This FX Views test for this asymmetry evaluates how severe it is currently, and tracks how it has evolved over time. We find that the response in $/CNY fixings became asymmetric in the direction of RMB weaker from March of this year, but has shown signs of abating recently. In a way, our results are statistical proof of a “bias to depreciate,” which we see as supportive of our shift to a more bearish RMB view this summer, after being more-constructive-than-consensus early this year. We continue to think that hedging RMB weakness is attractive, even with forwards moving to price a bit more depreciation.

Don’t forget, if the broad dollar rises, the USDCNY will have to skyrocket in order for the renminbi to remain stable against the trade-weighted basket- let alone depreciate:

cfets

(Charts: Deutsche Bank)

Clearly, this is a dangerous situation going into the US election. We all saw what happened in August of 2015 after the “surprise” deval (think Dow -1,000 points) and with the yuan pushing towards 6.80, it’s easy to imagine capital outflows picking back up. Here with some useful color is Bloomberg’s Mark Cudmore:

The Chinese yuan will be the next focus for the panic mongers after the U.S. election. At least until they turn to the Italian referendum and the expected December Fed rate rise.

After several months of stability, the yuan is finally breaking down again versus the China Foreign Exchange Trade System basket

This means that if the dollar jumps post-election, USD/CNY will smash through 6.80 and we could be challenging the post-financial crisis fixing level around 6.8270

Since investors seem to be inordinately focused on USD/CNY, this will generate much excitement and prompt renewed fears about uncontrollable capital outflows from China

Interestingly, this most recent leg of accelerated yuan weakness since mid-October has coincided with Chinese officials increasing property curbs. Perhaps this has intensified the motivation to get money out of the country. Hong Kong’s surprise move to increase stamp duty came amid renewed interest from mainland buyers that Bloomberg Intelligence said could herald further capital outflows

However, any excessive panic will likely be unwarranted. The PBOC may be letting the currency weaken again after a several months hiatus, but the pressures are significantly reduced since the January panic

For a start, the yuan has already fallen about 7% this year. That’s contributed to the economy re-accelerating, which means hard-landing fears have receded

The third-quarter current account surplus came in above estimates on Friday. The October trade surplus, due tomorrow, is forecast to bounce

Finally, something else that has been largely overlooked is that China recently relaxed the rules around foreign direct investment

FDI has been subdued for years due to the bureaucracy and hurdles involved but, as of October 1, government approval is no longer needed if investing in a non-restricted industry

So, while CNY is likely to become the focus of attention for doom-mongers after Wednesday, it’ll probably prove to be less of an issue than many fear. Just like all the other scares hyped already in 2016

Whatever you say Mark, but the outflows are indeed picking up again. Here’s Goldman with the October figures released today (emphasis mine):

The PBOC’s FX reserves fell US$46bn to US$3,121bn in October (Bloomberg consensus: -US$34bn; September: -US$19bn). After adjusting for estimated currency valuation effects, we estimate that the reserves fall would be about US$8bn (vs. estimated -US$27bn in September). But as usual, SAFE data on cross-border RMB flow and onshore FX settlement (out on Nov 16) should give important supplemental information on the underlying flow situation.

In other words, valuation effects are important to consider when you look at these numbers. Goldman looks at a number of factors and will likely be out with a revised reading later this month. Meanwhile the mainstream media is sounding the alarm bell. Here’s WSJ:

China’s regulators have acknowledged the pressure from money leaving the country but so far have dismissed concerns over capital flight.

One reason for the pickup, analysts and investors say, is that the yuan—or renminbi—is weakening faster again against the dollar, reigniting concern among Chinese individuals and businesses anxious to preserve the value of their domestic savings and assets.

The yuan has weakened 1.6% against the dollar since the end of September, even though Chinese authorities, who tightly control the currency’s trading range, have repeatedly pledged to keep it stable. Central bank efforts have helped ward off faster depreciation—the currency appreciated against the dollar during the first quarter of the year and rose again slightly in July and September—but the yuan is still down 4.2% versus the greenback this year.

wsj

I’ll give the last word here to Wang Fang, a school teacher who spoke to the journal:

“Can anyone tell me what has happened to the renminbi’s exchange rate? How much weaker can it become?”

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