Back in September, SocGen’s Kit Juckes delivered what he called “a Machiavellian read” on what was going on with the greenback, the yuan and Treasury yields.
Essentially, Juckes posited a link between an inflection in the dollar, yields, the euro, and the PBoC’s move to scrap the reserve requirement on FX forwards which was put in place back in 2015 in the wake of the yuan devaluation.
If you remember that note, you might imagine that Kit has a thing or two to say about Tuesday’s news that China has apparently suspended use of the counter-cyclical adjustment factor implemented last summer. If you haven’t read our explainer on today’s PBoC news, you probably should as it ties everything together quite nicely and is a prerequisite for fully appreciating Kit’s latest note which is itself a follow-up to the “Machiavelli” piece mentioned above.
Basically, the setup for the PBoC’s suspension of the countercyclical adjustment factor (i.e. a move to engineer some yuan weakness against the dollar) is similar to what we saw headed into September when China dropped the reserve requirement on FX forwards (also a move to engineer yuan weakness). The dollar was falling, the euro was rallying, the yuan was on a tear, and capital flight from China’s was abating. Here’s an excerpt from Juckes’ September note:
Plotting 10-year Notes against DXY provides the conventional view and the basis for what follows: The dollar turned higher as yields troughed, and once we’ve pried in a tax plan, a December rate hike, a couple more Fed hikes for 2018 and some political uncertainty in Europe, we can get back to our central scenario. But 8 September also saw the low in USD/CNH and USD/CNY. They have bounced because over the weekend of September 9/10, the Chinese authorities decided to scrap two measures aimed at supporting the Yuan when it was falling too fast (reserve requirements for institutions settling forward Yuan positions and foreign banks’ reserves against offshore Yuan deposits.
There’s much more to Kit’s “Machiavelli” thesis, but that will do for our purposes here.
Fast forward to Tuesday and here’s Juckes revisiting his September note:
When the Chinese authorities signalled that enough was enough and they didn’t want to see further Yuan strength last September, the following weeks saw a significant rise in Treasury yields, a correction in the EUR/USD rally and a broadly stronger dollar.
I’ve mentioned before that Chinese policy matters more for global markets than it used to, and Chinese policy moves tend to be decided rather faster than those in the US or Europe. I wouldn’t dream of pretending that I understand the thinking in Beijing, but it’s noteworthy that US yields are still rising after the slightly soft payroll data on Friday and an extension of a synchronised move higher in yields and the dollar would be similar to what we saw in September/October.
So who’s really in the driver’s seat here? As usual, there’s a strong argument to be made that it’s the Chinese.
As the chart in the left pane suggests, this is a chicken-egg situation worth pondering as you think about the road ahead for US yields and the dollar.