The dollar looks like it wants to a breather after the posting one of its best months since the election.
The greenback kicked off November on a sour note, down about 0.5%, presumably on profit taking and positioning ahead of the midterms, and that’s good news for the yuan, which folks are watching closely in light of escalating trade tensions and ongoing deceleration in the Chinese economy.
The Caixin/Markit Manufacturing PMI (out Thursday) painted a similar picture as the official data, printing just barely above 50, the line that separates expansion from contraction.
The market is alive with chatter about the dreaded 7-handle, a psychological level that many believe authorities will be keen on defending, even if it means selling reserves, which have generally remained stable of late, despite the rapid depreciation in the currency.
“We see good economic reasons arguing for a weaker yuan, especially in the coming months,” Goldman’s MK Tang said Wednesday, adding that “it’s only a matter of time for the yuan to hit 7.”
Meanwhile, the headline deluge out of Beijing continues as officials scramble to calm markets and reassure nervous investors that China is capable of shielding the economy from the trade frictions and avoiding a hard landing all without resorting to the type of policies which created the country’s massive private debt burden.
China has floated so many policy loosening trial balloons that it’s difficult to keep track of them all, and it’s worth noting that at a Communist Party Politburo meeting on economic policies, President Xi again emphasized that policy needs to be “proactive” in dealing with what he described as “profound” changes in external conditions. He indicated that the effects of current policy support have not yet been realized and, echoing his own and other officials’ promises, reiterated support for private enterprises.
As for whether all of this easing means the defaults are likely to stop, Moody’s says no or, at least that China is not going to go right back to automatic bailouts.
According to a note dated Thursday, China should “tolerate” more bond defaults assuming they remain isolated. “While the policy easing will alleviate refinancing pressure on the part of issuers, weak issuers remain vulnerable to default risk”, Moody’s says, adding that SOEs will benefit more from policy easing than private enterprises no matter what the government says because financial institutions are likely to believe the official backstop is still in place for state-owned enterprises. That said, Moody’s goes on to note that vulnerable SOEs will remain, well, they’ll remain vulnerable, and are “unlikely to receive much government support if they experience financial distress.”
As a reminder, “this is not a drill” (as they say):
As far as the yuan is concerned, it’s all about capital flight or expectations thereof. China seems to have a better handle on things now than they did in 2015 following the shock devaluation in August of that year, and as long as there’s no evidence of capital flight picking up materially, Beijing can probably continue to countenance currency weakness in the interest of cushioning exports.
Additionally, the PBoC has a dizzying array of policy tools at their disposal and just this week, they said they’ll sell 10b yuan in 3-month bills and 10b yuan in one-year bills on November 7 in Hong Kong. Obviously, the idea is to tighten up yuan liquidity and thereby support the currency.
“[The] timing of the PBOC’s planned tender suggests it is making preparations to pre-empt possible short-yuan positions built following the U.S. mid-term election”, Standard Chartered’s Becky Liu said in a note dated yesterday. She did add that the “impact on liquidity won’t be excessive”, but make no mistake, the PBoC has no qualms about getting “excessive” should circumstances warrant.
Anyway, the bottom line is that the next four weeks are going to be critical. If there’s no progress on trade and the yuan finally breaches 7 just as the U.S. publishes a new list in conjunction with planned duties on the remainder of Chinese imports, things are going to get very interesting, very quickly.