On Monday I took an in-depth look back at China’s trials and travails as they’ve played out since Trump’s victory at the polls.
In short, the Chinese had been hoping to tighten policy by stretching out the tenor of reverse repos and favoring 14 and 28-day ops over 7-day injections. That was supposed to discourage speculation and help to rein in the gamblers that use borrowed money to further inflate the myriad bubbles that plague the system.
Unfortunately for China, the tightening ended up conspiring with rising US bond yields and the stage was set for a sell-off in the country’s government bond market. Last Thursday, yields on Chinese 10Y govies soared the most on record and trading in some futures contracts was suspended. Ultimately, Beijing was forced to drop its preference for longer tenor liquidity ops in the interest of getting the market back on its feet.
All of this comes as capital continues to flow out of the country and as China cedes its title as #1 US creditor to Japan amid the selling of some $1.1 trillion in FX reserves (i.e. US paper) made necessary by excessive devaluation pressure on the yuan.
Indeed, the RMB has been one of the stories since August of 2015, when Beijing shocked the world (not to mention markets) by devaluing the currency and tipping the first domino in a chain of events that would culminate in a very “Black” Monday for global markets on August 24.
For those who haven’t followed the story or who otherwise need a refresher course in the history of the yuan, I thought it was worth posting the following RMB timeline out this morning from Goldman:
Our RMB view has also become more negative, presenting risk to the US dollar and S&P 500. When we published at the height of market anxiety around China, we were relatively constructive on the RMB, arguing that a large, one-off devaluation was unlikely and envisioning only a “mild” trade-weighted depreciation (against the CFETS basket, the CNY has depreciated 4.5% since then). But capital outflow pressures have remained, particularly in the context of US dollar strength. Despite the government’s official focus on a trade-weighted currency basket, higher $/CNY fixings are still a powerful signal that can easily re-ignite capital flight, as households and firms anticipate a faster pace of depreciation. Indeed, the PBOC’s FX reserves fell US$69bn to US$3,052bn in November, the largest decline since January. The US election has reinforced these dynamics given the strengthening dollar and potential for trade frictions, motivating tighter restrictions on capital flows. Global markets have so far taken these developments in stride, but the risk of a repeat of related equity market volatility remains, which could impact the pace of Fed tightening and dollar strength