On any number of occasions over the past two months, we’ve postulated that the only thing keeping the China contagion from spreading to EM more generally is a stable yuan.
The bottom line is that since China’s bungled attempt to devalue the RMB in August, 2015, bouts of yuan vol have been associated with all kinds of chaos and periods of stability have generally been accompanied by a more risk-friendly environment. The only chart you really need to understand that is this one:
So while the PBoC’s efforts to squeeze its shadow banking complex have played havoc with commodities and bonds of late, and while Chinese stocks have generally decoupled from the global equity euphoria, there hasn’t been an appreciable contagion effect. And that’s probably because Beijing has short-circuited the FX transmission channel.
Of course the other thing China likes to do (and this started in December, 2015 when the PBoC adopted a trade-weighted reference basket for the currency), is push the yuan lower against the basket while keeping it stable against the dollar. Effectively, this allows Beijing to kill two birds with one stone, but what’s amusing about the whole thing is that although everyone immediately saw through the charade in late 2015 (i.e. recognized it telegraphed further depreciation), people seem to have forgotten about this dynamic and are now focused squarely on the bilateral rate – which is just what the Politburo wants you to do.
Here’s some color on all of this out Friday from Bloomberg:
China has an insurance policy against a full-scale market meltdown: the daily currency fixing.
With stocks and bonds in retreat amid anxiety over Beijing’s deleveraging campaign, officials have been guiding the yuan higher against the dollar in a move that’s caught market watchers by surprise. After meeting expectations earlier in the year, the reference rate used by the People’s Bank of China to manage the yuan has come in stronger than the forecasts of four banks who regularly track the measure on 25 of the past 32 trading days.
“The PBOC is using the stronger fixings to prevent panic sentiment from spreading to the currency market,” said Xia Le, chief economist at Banco Bilbao Vizcaya Argentaria SA in Hong Kong, referring to the reference rate that’s updated each day.
While China has largely stemmed outflows through tougher capital controls, the PBOC is engineering a stronger yuan to preempt a renewal of those pressures amid the stock- and bond-market gyrations, says Khoon Goh, head of Asia research for Australia & New Zealand Banking Group in Singapore.
The fact the yuan is seeing stability against the dollar, but remains weak versus other currencies, suggests the stronger fixing run is a sentiment-boosting move. The PBOC didn’t respond to questions faxed to its press office on Thursday.
This effort may keep capital flight under control (for the time being), but there’s really no way to get around the knock-on effects from the vast deleveraging effort.
And while the currency is stable, interbank rates aren’t – which presages a potentially bumpy road ahead:
With the monetary “put” on its way out, the saving grace may be a fiscal backstop, because as Citi wrote on Thursday, the Chinese economy (and indeed the “global” economy), might just depend on it.
The tightening of credit & liquidity conditions in China is garnering market attention given that China has been the swing variable for global growth many times postcrisis. The latest China data reflect a sharply slowing economy. This led our China economists to suggest that the regulation led monetary tightening could be eased in the near term, as sharply rising real interest rates and deteriorating market sentiments have had a material impact on real economic activity.
This expectation that policymakers will again capitulate in the face of a serious downturn, and perhaps with a fiscal backstop, is the main explanation for why risk markets have been relatively sanguine. This policy put, in our view, must be the explanation for the relaxed risk asset backdrop because, as Figure 3 and Figure 4 shows, the China credit impulse tends to lead local economic data.
The implications for global growth are not so straightforward as correlations between the China credit impulse and G10 growth data (Figure 5) can be strong (2009 and 2013) or weak with the wrong correlation sign (2016). This reflects the other moving parts of the global economy and, in the current backdrop, the sharp increase in Euro area growth, where measured in US$ the Euro area economy is slightly larger than China.
The most consistent inference from the Chinese cycle on G10 rates is instead on inflation. We have spoken many times before about the importance of China PPI and how its cyclical peak in Feb17 portends lower inflation risk, as China Man PPI is coincident with Citi’s G10 inflation surprise index. As Figure 6 shows, the long leading indicator for inflation risk is the China credit impulse which has rolled over into negative territory.