After Wall Street’s Biggest Comeback Of 2019, All Eyes Turn To The Chinese Yuan

The next round of feared selling came.

And then it went.

A 589-point loss on the Dow had all but evaporated by the time the closing bell sounded on Wall Street Wednesday, a testament to something, although it wasn’t entirely clear what. Treasurys gave back all their gains by the end of the day, as yields rose in lockstep with the recovery in equities.

Maybe Art Cashin was right early in the session. “If we rolled over here and violated the morning lows, then it would really begin to be a problem”, the grizzled UBS veteran said, as stocks started to bounce. “For now, everybody is kind of crossing their fingers and whistling past the graveyard”.

Ultimately, they “whistled” their way to the biggest comeback on the S&P and the Nasdaq of the year.

Still, the manic price action and harrowing swings aren’t likely to inspire much confidence among those concerned about a repeat of 2018’s wildest weeks. “I think volatility is here to stay”, Cashin went on to warn.

And besides, it’s not exactly like there was any real news to invalidate the growth concerns and trade jitters that helped set the tone for Wednesday’s early bloodbath. In fact, Sino-US tensions mounted throughout the day, with Global Times editor Hu Xijin effectively ruling out negotiations in the near term. Donald Trump’s rhetoric was confrontational on a number of fronts.

Still, some are optimistic. Take Evercore’s Rich Ross, for instance, who on Wednesday afternoon suggested the technicals point to a bottom. The reversal in stocks “remains consistent with a bottom and bullish reversal”, he wrote, in a note, adding that benchmark yields in the US are “finally display[ing] evidence of short term exhaustion”. That, Ross contends, may be “the first step towards a tactical low”.

Fingers crossed, Rich, but people have been searching for a low in bond yields since late March. The only thing they’ve found is lower traded inflation, rate cuts and collapsing growth expectations.

Consider also that Monday’s plunge brought the S&P to within a couple of basis points of a 3% decline, and according to Bloomberg Intelligence’s Gina Martin Adams, there have only been two cases over the past dozen years when that’s happened without a 10% correction.

Martin Adams is looking for a stabilization in the yuan before giving the all-clear, and that, friends, is where the problem comes in.

Wednesday’s fix was perilously close to 7. If the PBoC sets the fix weaker than 7 going forward, it could be seen as a green light for the currency to fall further.

“The US and China are increasingly engaged in an entrenched tit-for-tat escalation phase [and] one of the two sides probably need to reach their pain limit before there is a chance of a de-escalation phase”, SocGen’s Jason Daw and Phoenix Kalen wrote, in an EM FX update on Wednesday. Consider this additional color from their note:

Policymakers could tolerate USD-CNY staying above 7.0 on a sustainable basis unless the unlikely situation evolves that the US tariff threat is retracted, a solution is reached prior to Sep 1, or somehow global / Chinese growth spontaneously improves.It won’t be a straight line higher in USD-CNY. The Chinese authorities can deploy their formidable defences to stop or slow the depreciation, and they may want to see the impact on capital flows before permitting another leg higher. However, the upside risks to USD-CNY have intensified and we now forecast USD-CNY modestly higher than our previous forecasts (to 7.10, 7.15, 7.20, 7.25) over the next four quarters. If the US escalated the tariff fight further (i.e. 25% tariffs on the remaining $300bn of Chinese imports) or took other measures against China, it would not be inconceivable for USD-CNY to rise to 7.50 or higher.

Remember, on some estimates, the yuan would need to depreciate to 7.30 (give or take) just to offset the prospective 10% tariff on the remainder of Chinese imports scheduled for September 1. An escalation to a 25% levy on those goods would likely see the currency fall much harder.

The title of Daw and Kalen’s note: “Playing with fire”.