Ok, dammit. There is apparently no stopping the yuan.
Back in late May/early June, the PBoC engineered an epic short squeeze. That effort included the introduction of an absurdly opaque “counter-cyclical adjustment factor” that, attempts to spin it notwithstanding, amounted to a partial rollback of the liberalization push instituted in August 2015.
The short squeeze could have been meant to appease Trump, but I would argue the more likely explanation was that China wanted to get out ahead of the June Fed hike. In March, the PBoC hiked OMO rates hours after the Fed, presumably in order to avoid a scenario that would have seen rate differentials move in favor of the dollar. But that avenue was well nigh exhausted by June. In order to avoid the risks inherent in overtightening (e.g. unwinds in trades financed via shadow conduits and pressure on inflation) Beijing instead chose to simply put a pause on the FX liberalization. They would intervene in the spot market multiple times over the next 30 days to ensure the yuan continued to strengthen. The point: ensure that the Fed hike didn’t end up contributing to more capital flight from China. Of course markets interpreted the Fed as “dovish” and Trump’s trials and tribulations have kept pressure on the dollar, but it seems to me that China wasn’t interested in seeing how things were going to play out. They engineered yuan strength to inoculate themselves because right now, they seem to believe that the greater risk is renewed capital outflows, not a stronger currency weighing on exports.
Fast forward to today and the yuan is riding a truly incredible hot streak. We’ve documented this extensively. On Tuesday, that winning streak hit 10 days, marking the best run in 7 years.
Headed into the overnight session, some folks were out suggesting that bank earnings could create still more yuan strength.
"The downtrend for USD/CNH could receive another boost on Wednesday as China's big four banks report earnings"
notable
— Heisenberg Report (@heisenbergrpt) August 29, 2017
The numbers were solid and while I won’t get into the details because it seems likely that no one cares, here’s a quick rundown from Bloomberg:
Resilient economic growth and a government campaign against excessive leverage are helping China’s largest banks, curbing their bad loans and underpinning their net interest margins.
Those factors helped three of the big banks post higher-than-estimated second-quarter net income, led by Bank of China Ltd.’s 23 percent surge, the biggest increase in six years. Largest rival Industrial & Commercial Bank of China Ltd.reported a 2.3 percent gain, while Agricultural Bank of China Ltd. had a 4.8 percent increase, according to figures derived from first-half earnings reported to Hong Kong’s exchange on Wednesday.
It’s worth noting that these results were probably helped by the fact that these mammoths are lending into an interbank market where rates are now higher. And because they don’t rely on shadow funding to the extent the smaller players do, there’s less of a squeeze from Beijing’s deleveraging effort. That, in turn, helps to explain this juxtaposition:
Whatever, right?
Well the bank numbers came in after the initial surge, but whether you care about the banks or not (and you should), the yuan is something you have to pay attention to and by God it’s up again today.
The PBoC set the fix stronger for a third consecutive day (up 0.29% to 6.6102) and ultimately the offshore yuan strengthened all the way to 6.5851 at one point, before paring gains.
This is 11 straight days – the longest streak since September 2010.
And to let Jitipol Puksamatanan – a Bangkok-based strategist at Krung Thai Bank – tell it, the only thing that’s going to stop this train is war.
“The onshore yuan will end this year at 6.50 per dollar unless there is a military conflict in Asia,” he told Bloomberg in a phone interview this week. “Although the yuan has gained sharply, we don’t expect a major correction in the near term because Chinese exporters would take any weakness in the yuan as a chance to sell dollars that they have accumulated.”
Hilariously, even that might not stop the yuan from strengthening because as we’ve been keen on pointing over the past couple of weeks, the currency is starting to act like a safe haven every time North Korea jitters intensify.
Draw your own conclusions, but one has to think that there will come a point when the pressure this puts on the economy will outweigh the risk of capital flight that could accompany any effort to put the brakes on.
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