Ok, so I’m admittedly biased, but I think I can say with some degree of confidence that China, the RMB, and Hong Kong money markets are among the most important stories on Thursday.
As noted earlier this morning, yuan funding costs are soaring on the heels of Beijing’s stepped up capital controls and renewed vigor with regard to controlling the pace at which the RMB depreciates against the dollar. CNH HIBOR hit its highest levels since September this week while CNH NDF points and O/N depo rates hit records.
And while the RMB is getting a near-term boost, don’t bet on the overall trajectory changing any time soon.
Here’s SocGen with some color:
A slow upward grind in USD/CNY, orchestrated by the Chinese authorities to prevent unwanted strength of the currency on a trade-weighted basis and reverse some of the gains of recent years, is a key element of the 2016 market outlook. It’s not the only element of course – the prospect of US economic outperformance fuelled by easier fiscal policy, and the implications for Fed policy which contrast so sharply with what the ECB and BOJ are doing, along with the rise in oil prices and concern about a resurgence of protectionist behaviour, may matter more. But as CNH short-term rates lurched higher overnight, there were echoes of the move we saw this time last year when tighter liquidity and triggered a rally for the Yuan and set the stage of the dollar’s reverse – a 6% trade-weighted fall between mid-January and early May that was only fully reversed by the presidential election.
We think tighter capital controls are stop –gap measure that may plug one hole but won’t prevent another one emerging elsewhere. Further CNH and more importantly further CNY weakness seems inevitably to us and indeed, desirable for the Chinese economy. However, challenging the market narrative that has seen investors and traders pile into the dollar since early November, is enough to trigger a sharp cutback of longs, not just in USD/CNH but across G10FX until liquidity conditions ease.