Have you considered the possibility that the dollar is on the brink of a “super spike” amid a race to the bottom in Asia?
Probably not. Although the greenback is the strongest in years, incessant “new world order” banter perpetuated by one man’s attempt to write the history of the 21st century 80 years too early, suggests many market participants are under the impression that Art Vandelay is now using an equal-weighted basket of rubles, yuan, gold ingots and beaver pelts for invoicing.
Fairy tales aside, the dollar is still a thing, believe it or not, and according to one popular strategist, the greenback could be due for a sharp rise in the event the burgeoning “Asian FX war” escalates. Hold that thought while I walk you through recent events.
The yen, you’ll note, is a hot topic. The BoJ’s commitment to easing (manifested over the past several weeks in Kuroda’s defense of the YCC cap) makes for a stark juxtaposition with the Fed’s aggressively hawkish bent. That policy divergence perpetuated the longest losing streak for the yen since 1971. Some analysts believe the USDJPY story is the most important dynamic in the macro universe.
A knock-on effect is dramatic cheapening of the yen versus the yuan (figure below).
That matters. And SPI Asset Management’s Stephen Innes explained why. “If Japanese exports start to pick up as a result of a weaker yen, this would hurt exporters across Asia but mainly China and Korea,” Innes said, adding that the PBoC is “watching the yen like a hawk.” “No one wants to be caught behind,” he remarked.
The RMB is coming off a dramatic week. The offshore yuan dropped the most since the 2015 devaluation (figure below) and dollar-yuan landed at the top of the most active list in options for two consecutive days.
Implied vol is sharply higher, the cost to short the currency is low, risk reversals are heavily skewed towards dollar strength and a very weak fix on Wednesday was described by some analysts as a “one-off” adjustment aimed specifically at the yen.
“I believe the intention is not to start a weakening trend, but more to ensure it adjusts to align with other currency moves, like yen weakness recently,” Khoon Goh, head of Asia research at ANZ, said, of Wednesday’s fixing.
Thursday’s fix, on the other hand, was in-line and Friday’s stronger than expected, which supported the “adjustment” thesis. “Steady CNY depreciation is increasingly likely [but] the PBoC doesn’t want its currency depreciating as quickly as Japan’s,” Innes wrote.
Like Japan, China is attempting to manage a growing monetary policy divergence with the US, which has eroded Chinese bonds’ yield advantage over Treasurys. The PBoC held off on an MLF cut in April, and there was no reduction to the loan prime rates.
In the context of official pledges to support growth, the reluctance to ease further (which was also evident in what some viewed as a weak-willed RRR cut) could signal wariness about excessive RMB depreciation, especially considering recent outflows from stocks and bonds (figures below, from TD).
Official media, including the Securities Times, tipped the potential for additional CNY weakness, but reminded the market that during the worst of the trade war, the yuan was ~7.10 to the greenback, so there’s “ample room to release deprecation pressure” without triggering a panic.
USDCNH traded through (i.e., above) 6.50 for the first time since August on Friday.
For BofA’s Michael Hartnett, things are clear-cut. “The yen has been devalued to the cheapest level versus the Chinese renminbi in almost 30 years, and in lockdown, China’s new orders are contracting, retail sales are down and, most ominously of all, the Chinese unemployment rate has jumped,” he wrote. “China is now responding to a weak yen and Korean won via currency weakness,” Hartnett continued.
SocGen’s Albert Edwards adopted a similarly straightforward cadence. “One thing is clear to me: The super-weak yen of 2013-15, by driving down other competing Asian currencies, ultimately led us to the August 2015 renminbi devaluation,” he said late last month.
“Once again, a weak yen is leaving the renminbi looking increasingly overvalued,” Edwards added.
Although China’s trade balance is likely to serve as a check on depreciation, Bloomberg captured the zeitgeist on Friday. “Traders are unwinding structural bets on yuan strength and positioning for a stronger dollar,” Mark Cranfield and David Finnerty said.
Coming full circle, BofA’s Hartnett suggested the near-term read-through of an FX war in Asia may be “a super-spike in the US dollar” which could “signal a temporary break in the commodity fever.”
Kudos for using an episode from the 1st season–the creation of Art Vandelay!