We’ve been talking all month about the yuan, and for good reason.
Ever since the PBoC added the counter-cyclical adjustment factor to the fix (part and parcel of the engineered short squeeze that unfolded in late May/early June), the yuan has been a one-way trade against the dollar.
Indicative of the resilience, the currency managed to shake off weaker-than-expected July trade data earlier this month as the market looked straight through the import/export miss to the still sizable surplus. Thursday’s manufacturing PMI printed ahead of expectations and seemed to lend credence to the notion that Beijing is so far succeeding in efforts to keep the ongoing deleveraging push from choking off growth to the real economy.
Through Wednesday, the offshore yuan had risen for 11 consecutive sessions, the longest streak since September 2010.
Another notable feature of the rally is the extent to which the currency is starting to behave like a high-yielding safe haven. As Bloomberg’s Mark Cranfield noted earlier this week, “yuan strength during periods of North Korea related turmoil is becoming as reliable as the demand for yen or gold.” You can see this manifested in CNYKRW (more here).
Well, as we close out August, you should note that this was the best month for the onshore yuan since it was revalued and taken off a fixed dollar peg in 2005.
You’ll also note from the chart that CNY strengthened for a fourth month in August – that’s the longest streak since October 2014.
Bloomberg also reminds you that the CFETS index (i.e. the basket) has risen to its highest since late January.
Apparently (or maybe “obviously” is better), the PBoC doesn’t mind what’s going on. “It’s clearer that the PBOC is happy with the currency’s strength,” Barclays FX strategist Dennis Tan told Bloomberg by phone on Thursday, adding that the market’s confidence in the PBoC’s position has “sparked yuan-buying flows in stop- loss trades and led corporations to sell dollars.”
Here’s a bit of color out from Goldman earlier this month:
What has caused $/CNY to decline so far this year?
1. The fall in $/CNY year-to-date: a slightly weaker CNY outweighed by a much weaker USD.
2. Further capital control measures have slowed outflows Another reason why CNY has been stronger than our previous forecast is the effective capital control measures. This year the authorities have implemented further capital control measures (see Exhibit 3 for a summary of these measures).
3. The economy has been stronger than expected, especially in nominal terms Another reason for our CNY forecast error is a stronger-than-expected Chinese economy—especially in nominal terms, which means there is less cyclical pressure to depreciate.
4. Episodic efforts by the authorities since May to negate bearish CNY sentiment One particular reason for the overall incremental CNY TWI appreciation since May appears to be the authorities’ episodic efforts to send messages to the market to negate bearish CNY sentiment. This kind of “message sending” policy practice by the authorities appeared to happen twice in late May and late June—both times after the market had been more bearish on the CNY than what the authorities’ revealed preference indicated.
Right. And see here’s the thing: divining anything from this is made immeasurably more difficult than it would be otherwise by virtue of the back-and-forth on trade between Trump and Xi and by the fact that this is a politically sensitive year in China. Here’s Goldman summing things up:
The fact that the party congress is approaching and the US-China trade negotiations are still on-going makes assessment of the underlying CNY trend all the more difficult, given potential politically motivated policy support for the currency. But in any case, over time, in light of the top Chinese leaders’ call for deleveraging the domestic economy (hence increasing the importance of export support) and apparent under-diversification of Chinese residents, we continue to see further CNY depreciation over the medium term, albeit at a more moderate pace than in the past two years.
So I guess the question here is this: what happens when the factors keeping this going are in the rearview and yuan strength starts to weigh on the economy?
More to the point: how prepared is the market for that day when the fix hits and everyone suddenly realizes that the PBoC has had enough? Because that’s inevitable.