Early in June, during an interview with Bloomberg Television, PBoC governor Yi Gang indicated that no one level on the yuan is any more important than another.
That suggested 7 was not, in fact, a line in the sand. Nor should it be, because as we (and others) have been keen to point out, defending a meaningless level only serves to reinforce the psychological importance of that level in the mind of the market, thereby creating unnecessary risks around a possible breach.
On Monday, global markets got a taste of what happens when a psychological threshold that’s been mythologized in the minds of traders falls. In retaliation for the Trump administration’s latest trade salvo, the PBoC set the fix much weaker than expected, triggering a drop through 7 for the offshore yuan. The rest is history.
Fast forward to Thursday and the PBoC finally broke the seal on the fix, setting the reference rate at 7.0039. Tuesday’s fix was stronger than expected, which played a role in stabilizing risk sentiment, but as we noted on a couple of occasions throughout Wednesday’s US session, Wednesday’s 6.9996 fix was precariously close to 7, which meant traders would be watching closely.
Although this is a landmark moment, Thursday’s fix was actually stronger than estimates (7.0156). Additionally, it’s worth asking whether the yuan finally fixing through 7 may paradoxically serve as something of a pressure valve. Indeed, USDCNH moved quickly lower on the news.
“A weight has been lifted off the yuan now the daily USD/CNY parity fixing has exceeded 7.0 for the first time since 2008”, Bloomberg’s Mark Cranfield wrote Thursday morning, adding that everyone can now get back to focusing on what’s important in terms of data, news flow and, of course, Donald Trump’s tweets, which are synonymous with “news” when it comes to the trade war.
Risk appetite appears to have gotten a fillip on the stronger-than-expected fix. Treasury futures trimmed gains, US equity futures blipped positive and oil rose. Meanwhile, trade data for July came in better than expectations. Imports fell 5.6% in dollar terms, versus expectations for a 9% drop. Exports managed a 3.3% gain. Consensus was looking for a 1% decline in July. Although the data needs parsing, the headline beats are ostensibly good news, especially under the circumstances.
“In the near term, we think the PBoC is likely to anchor USDCNY expectations in the 7.05-7.10 range”, Barclays wrote Wednesday, before cautioning that “with China’s economy likely to slow further into next year and the PBoC indicating its openness to further currency adjustments, we see USDCNY rising to 7.25 into 2020”.
Other desks have similarly ratcheted higher their USDCNY targets over the course of the last week. “The upside risks to USDCNY 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”, SocGen said Wednesday, for instance.
Beijing will likely want to avoid runaway depreciation, at least until the White House does something else deemed unforgivable to Xi.
Still, there’s more than a little ambiguity around what kind of depreciation will be needed to offset the tariffs Trump plans to impose in less than four weeks.
“A 10% devaluation of the RMB against the USD will cancel the impact of a 10% tariff on the prices of Chinese goods sold in the US [but] some cross-country studies have shown that the elasticity of export to tariffs is much bigger than the elasticity of export to devaluation, suggesting that a devaluation three times greater than the tariff may be necessary to neutralize the impact of tariff”, BofA said this week, before exclaiming that if that’s any semblance of accurate, “it could take as much as a 30% devaluation of the RMB to offset the impact of a 10% tariff on Chinese imports in the US”!