As Yuan Short Calls Grow, Will Coronavirus Infect US-China Trade Deal?

Despite a stronger-than-expected fix coming off the holiday, the onshore yuan sank the most since August, in a painful catch-up with the offshore market, where the currency slid back through the “magic” 7-handle last week.

The PBoC cut the 7- and 14-day repo rates on Monday in the course of injecting a record 1.2 trillion yuan into the system (but only a net 150 billion), and speculation that more easing is in the cards is almost surely adding to the bearish pressure.

On top of that, concerns that China’s economy could suffer a body blow as the coronavirus outbreak weighs on activity at a delicate juncture will likely serve as a serious drag on sentiment.

“Asian FX continues to look vulnerable, with the soft but unsurprising weakness in Chinese markets weighing on regional currencies”, Mitul Kotecha, TD’s senior EM strategist, said Monday.

“These are just the beginning of monetary and credit easing in China’s national campaign against the coronavirus”, Nomura’s Ting Lu, who last week said markets should expect a series of easing measures in the days ahead, remarked, adding that although the policies “are meant to help enterprises survive this epidemic, we think they are unlikely to prevent a significant growth slowdown” in Q1.

That echoes his assessment from last week and now, Nomura says shorting the offshore yuan makes sense considering the likelihood that the PBoC isn’t done. On Sunday, we noted that a cut to the MLF rate is likely in the cards. Nomura sees a 10bps cut in the coming weeks, matching the repo rate cuts delivered on Monday. That would set up a 10bps cut to the revamped loan prime rate later this month. All loans are being transitioned to LPR this year.

The bank also sees the PBoC delivering another RRR cut of between 50 and 100bps. That would come on top of last month’s cut. Here’s where things stand currently:

Here are some additional highlights from Nomura’s note:

• We expect authorities to grow bolder on fiscal deficits and increase the transfer of central government revenues to local governments in virus-affected regions, with Beijing raising the fiscal deficit target as well as raising the annual quota of net local government special bond issuance in 2020
• We expect Beijing to introduce favorable tax policies to boost final demand, such as cutting the auto purchase tax to boost auto production and sales
• Perhaps most critically, we expect authorities to give local governments more flexibility in easing restrictions on the property sectors (e.g. price controls, caps on new home purchases and property developer financing), while also rolling-out more favorable urbanization policies to attract talent and migrant workers to large cities to beef up production and consumptions

Finally, the bank suggests that the coming weeks may bring “increasing market doubts over whether China could fulfill its phase-one trade deal commitments” with the US.

That may become a critical consideration for markets going forward. Indeed, US officials were already broaching the subject last week.

“[The virus] obviously is going to have some ramifications economy-wide, which we hope will not inhibit the purchase goal that we have for this year”, Agriculture Secretary Sonny Perdue said Wednesday, on a conference call from Rome. “We’ll have to look ahead and see. But the honest answer is we just don’t know yet. But we’re hoping for a very quick conclusion”.

Here’s a reminder of what China has promised to purchase under the “Phase One” deal:

How this evolves will have ramifications for the broader FX space, too. “The Chinese yuan is the currency with the biggest weight in the basket that determines the value of the European Central Bank’s trade weighted euro index”, SocGen’s Kit Juckes wrote Monday. “It isn’t a surprise, therefore that moves in the euro and yuan are positively correlated”, he went on to say, adding that neither is it surprising “that this correlation has been weaker in recent weeks as the coronavirus epidemic replaces trade talks with the US as the main driver of the yuan’s value”.

As alluded to above, the trade talks and the epidemic could soon become entangled, just as national security and trade became inextricably bound up last year.

The Trump administration will claim the two are entirely separate issues, but remember: They said the same thing about national security and trade and those two things hardly remained “separate”.

Read more: A Corona(virus) Gets Its Lime