There’s no relief in sight for Chinese stocks. Mainland shares were down again on Thursday, sinking further into bear market territory as the market continues to fret over Friday’s tariff D-Day.
Of course the bigger (or perhaps, “more important” is better, because equities always manage to grab the limelight, even if they aren’t, in fact, the most critical component of a given market narrative) story is the Chinese yuan, which is a victim of circumstance in the prevailing environment.
The Chinese economy is decelerating, which means authorities need to at least temporarily deemphasize the deleveraging push and loosen policy. The threat of a slowdown catalyzed by trade frictions only exacerbates that situation.
But because the Fed is tightening, looser policy from the PBoC means more policy divergence between the U.S. and China, which in turn gives the market another reason to expect yuan weakness. In fact, the recent sharp move higher in USDCNY is really just the bilateral rate playing catchup to rate diffs:
Currency depreciation isn’t the worst thing in the world for China right now – it softens the blow from the trade tensions and to the extent the PBoC can claim the weakness is market-based, well then they’ll take it. Or at least they’ll take it for a while; apparently 6.85- 6.90 is actually where you want to watch for overt intervention (as opposed to 6.70, the “magic” number being bandied about of late).
Yi Gang did step in with some jawboning earlier this week and policy banks did sell some dollars at ~6.70, but what we saw on Tuesday wasn’t a concerted effort to forcibly push back against the market.
Do note, however, that the decision not to follow the Fed last month and the RRR cut are still policy choices, even if they’re primarily designed to keep liquidity ample and not aimed directly at the currency. In the same vein, the decision to do nothing is still a decision. Here’s SocGen’s Jason Daw on that:
Did China actively depreciate the CNY in response to US tariffs? We cannot know for sure, but whether it was purposeful depreciation or greater tolerance of more FX volatility still means it was a policy choice to let it fall so far and so fast.
And here’s SocGen’s Albert Edwards from his latest note, dated Thursday:
After May’s shockingly weak Chinese retail sales, fixed asset investment and credit growth, the PBoC had to be seen to be doing something, especially since US tariffs of 25% on $34bn of Chinese goods will come into effect on 6 July. Our economists estimate the drag on the Chinese economy could be close to 1% of GDP and cost 3-4m Chinese jobs, while for the US, the drag on GDP would be more modest at just 0.1-0.2%.
Hence it was no surprise that the PBoC cut by 50bp RRR for the largest banks to 15.5% (effective July 5) for the third time this year. With the economy looking increasingly vulnerable it simply has no choice but to ease aggressively. And with the Fed heading decisively in the opposite direction, is it any wonder the renminbi slumped in June?
In any event, it will be interesting to see how the yuan holds up over the next several sessions. After all, we’ve got the Fed minutes, June payrolls in the U.S. on Friday and the official imposition of tariffs, all coming down before the weekend.
It’s possible that the Fed minutes and the jobs report go even further towards cementing the policy divergence narrative, a state of affairs which could conceivably conspire with the tariff reality to catalyze more yuan weakness or, perhaps, intervention. Or maybe not. Unlike everyone else on the planet, I don’t pretend to know how any of this is going to pan out, all I know is how it all fits together.
For his part, the above-mentioned Albert Edwards notes that “it is difficult to see how, if Chinese interest rates are being slashed, the renminbi can do anything other than fall sharply.”
While that’s a common sense take, do note that the PBoC has so many levers to pull that it’s hard to keep track of them all. For instance, they drained some 140 billion yuan from the system through OMOs on Thursday, which brings the total withdrawal since June 25 to 760 billion or, more to the point, 60 billion more than the liquidity unlocked by the RRR cut.
And while the yuan moved sideways versus the dollar on Thursday, it rose against the basket for first time since June 19 in what was the biggest gain in 10 months.