The Market Has A New Safe Haven Asset – But You Missed The Rally

This market has a new (and unlikely) safe haven asset: the Chinese yuan.

Earlier this week, some folks were surprised to see the yuan rally following “disappointing” trade data. Specifically, imports and exports missed badly, and yet the onshore yuan strengthened past 6.70 for first time since October.

We endeavored to explain things as follows:

When you think about the yuan, don’t forget these numbers:

• CHINA JAN.-JULY TRADE SURPLUS AGAINST U.S. $142.8B
• CHINA JULY TRADE SURPLUS AGAINST U.S. 172.4B YUAN
• Trade balance: US$46.7bn; consensus: US$45.0 bn in July

It seems pretty clear to me that when it comes to the bilateral rate, people are just staring at that surplus.

Of course it’s not just the trade surplus. The market has become convinced that Beijing has effectively won the battle (if not the war) against outflows and the “proof” is in the FX reserves data. Of course the veracity of the headline numbers is up for debate, but the bottom line is this: between the surplus, the stable reserves, tight capital controls, and the trials and tribulations of the dollar, the yuan is sitting near a one-year high. Notably, it’s also starting to strengthen against the basket – i.e. this is not strictly a bilateral phenomenon.

Here’s a bit more color from Bloomberg’s Cameron Crise:

More recently, the CNY (and CNH) defied the lazy consensus of the past couple of years and rallied hard against the dollar. What’s going on? First, much of the apparent CNY strength is in fact just weakness in the dollar. As recently as last week the yuan wasn’t far off the bottom of its 2017 range versus its reference basket. Over the last couple of days, however, the currency has appreciated on a broader basis. I’d offer a couple of explanations here. The prosaic one is that the long-standing calls for the Chinese currency to depreciate simply haven’t worked and have been squeezed out. In fact, given the break of supports in USD/CNH there are no doubt local players and momentum jockeys piling into long CNH/short USD positions. The forward market is a pretty good proxy for speculative pressure on the currency; the implied CNH yield in FX forwards has collapsed, indicating strong flow into the currency. That the latest jump in the currency has come as tensions with North Korea have escalated may be a coincidence, but it seems kind of unlikely. Perhaps the jump in the RMB complex reflects the idea that China may win an acceptance of its regional influence from Washington? While that’s clearly not news on a de facto basis, but a de jure acknowledgement from the White House is surely a positive for the country. Or maybe it’s all just a reaction to China’s authorities stamping down on capital exportation.

One thing you have to understand here is that thanks to the adoption of the “counter-cyclical adjustment factor” during the great yuan short squeeze that unfolded in late May/early June (i.e. ahead of the Fed), China can exert control over the currency without having to directly intervene – that was the whole point of introducing the adjustment factor into the fix and indeed, it marked a de facto return to the more controlled FX regime that existed prior to the August, 2015 devaluation.

Ok, so the question now is obviously this: can the rally continue?

As usual, that depends on who you ask, but it’s worth noting that it looks overbought:

Remember (or maybe “ren”member” is better – get it?) this is all about expediency and prioritizing for China. In late May/early June, the priority was making sure they got out ahead of the Fed in case a hawkish interpretation of the rate hike caused yield differentials to move in favor of the dollar. Earlier in the year, China simply hiked OMO rates following the Fed, but that wasn’t an option in June as the market was worried about overtightening. So they simply rolled back FX liberalization and squeezed the shorts, obviating the need to hike with the Fed.

Well now, with exports and imports starting to roll over, the question becomes whether expediency now calls for a weaker yuan.

“Into year-end 2017, I think much of the move lower in the dollar-yuan rate is finished,” Skandinaviska Enskilda Banken AB’s Sean Yokota tells Bloomberg. “The PBOC’s fixing behavior has recently turned more neutral and does not show a bias to strengthen the yuan against the dollar as we saw in May and June. The PBOC doesn’t need to see a strong currency when exports are slowing.”

Place your bets and do note that this was just one more example of (virtually) everyone getting it wrong, a contention that’s backed up by the following hilarious chart which shows the analyst community’s collective about-face: