China FX yuan

As Wuhan Virus Spreads, Will The Yuan Get Sick?

Assuming at least some of us live to trade another day...

As of Saturday, nearly four-dozen people had died in China from the Wuhan virus. Some reports suggested local hospitals are increasingly overwhelmed.

The number of cases in mainland China reached 1,400, and the virus has now spread to Australia, Malaysia and Pakistan.

The China Development Bank is rushing more than $250 million in emergency response funds to Wuhan to help control the outbreak. Outbound tours and domestic group tours are banned, and no buses will be allowed into or out of the city starting Sunday. The US will evacuate nearly 100 Americans on a charter plane this weekend, according to Dow Jones.


The immediate concern is obviously whether we’re all going to perish from a mysterious respiratory infection, but assuming at least some of us live to trade, one question for markets is what effect this has on the yuan.

Trade optimism, signs of stabilization in the data and the removal of the currency manipulator label helped the yuan surge over the past several months, but it fell the most since August this week as virus fears proliferated.

As we’ve seen repeatedly since the August 2015 devaluation, bouts of sudden yuan weakness can be extraordinarily destabilizing for global assets of all stripes.

Although depreciation brought about by some unforeseen shock (as opposed to engineered depreciation by the PBoC) could be less of an issue, this is something to watch, especially if the situation continues to worsen over the course of the Lunar New Year, presaging larger “catch up” moves for Chinese assets and PBoC guidance once the mainland comes back online after the holiday.

JPMorgan on Friday mentioned buying USDCNH 3- to 6-month volatility as a virus hedge (call it a “vaccine”). “The threat from escalating severity of the coronavirus outbreak is focused on Asia and services, the two sectors which have led the global recovery”, the bank wrote. “Until this new significant unknown is resolved, it puts an even greater onus on the expected global capex recovery to deliver and to reassume global growth leadership”.

It’s possible that any outsized reaction in the yuan over the next month could keep the Chinese currency at the forefront, just when the abatement of the trade war and the stabilization of the world’s second-largest economy had seemingly set the stage for “market energy to migrate elsewhere”, to quote SocGen’s Kit Juckes. Here’s a longer passage, from a note out earlier this week:

In a tripolar foreign exchange world, one of the three main currencies (the dollar, euro and yuan) will dominate at any one time. When that happens, correlations will shift. The heightened focus on US/Chinese trade relations and the search of a deal in the second half of 2019 helped sustain high degrees of correlation between USD/CNY and EUR/CNY, EUR/SEK and AUD/USD amongst others, but the correlation between USD/CNY and EUR/USD collapsed. With all eyes on the US and China, a beaten up euro has languished in a range. With the Phase One trade deal signed, that may change as USD/CNY settles down and market energy migrates elsewhere.

For their part, TD on Friday recommended longs in USD/KRW or USD/INR for the first two weeks of the virus’s spread, and shorts in CNH versus EUR or JPY in the event the outbreak gets materially worse.

Suffice to say the news on Saturday qualifies as “worse”.


 

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