The Chinese government gave the green light for a controlled yuan depreciation, refraining from aggressive interventions. USDCNY hit the 6.81 level on Friday, but thanks to dollar sales made by Chinese banks, the RMB managed to regain losses and surge higher against US Dollar.
The wave of sales in the Chinese markets was well marked by the outflow of capital from the offshore CNH market, which has free pricing as opposed to the CNY, whose exchange is tightly regulated. The USDCNY-USDCNH spread widened sharply today, before it was cut by the arbitrage forces. Since the beginning of June, the spread has shifted to negative territory indicating chronic pressure on CNH, as in the case of risk-on moves, the first who liquidate Chinese assets are investors who invested through the offshore renminbi as there are no capital controls.
In general, PBOC has found a convenient tool for tracking investor sentiment – CNH. The market is tiny, but very useful as it allows insight into the scope of capital flight. The currency regime of CNY with restrictions on the inflow / outflow of capital tends to accumulate problems associated with the inability of investors to leave the troubled market.
Chinese turmoil seemed to be gaining momentum with corporate default of Wintime Energy Co., the largest bankruptcy in history. Wintime Energy Co., a coal mining company, has defaulted, with more than $10 billion debt. In four years, the company had increased its debt fourfold, while the last placement of bonds saw quite low demand, which signalled the rapid deterioration of credit rating. Wintime Energy also pledged its own shares for loans, which indicates the scale of the problem in the corporate debt market in China, which traces pyramid schemes and poorly controlled risk-taking.
Yuan slump is becoming a heavy burden for Asian markets, which have strong economic ties with China. There are several reasons for this. First, the cheap yuan undermines the competitiveness of other Asian economies. Secondly, it is the outflow of capital, which is simply a consequence of the deteriorated outlook. Thirdly, this is a threat of intensifying the trade conflict, as China can be labelled as a currency manipulator.
In the foreign exchange market, Trump managed to get the dollar lower yesterday by saying that a strong dollar is a disadvantage for the economy. This was not the first time Trump made similar statements, but as he generally changes his position several times throughout his statements, which weakened the reaction of the markets to his statements. From the view of protectionist policy, Trump certainly needs a weak currency and low rates, since this is a traditional measure of exporters’ protection, as also seen in Japan (for which it is generally a panacea).
As a president, Trump must refrain from commenting on the dollar, as such verbal intervention can be deemed as a direct intervention in monetary policy, which is the exclusive prerogative of the Fed. It is also not common for presidents to make indirect comments, leaving markets to interpret the consequences for the US currency.
Trump seemed to be discontented with the Fed’s rate hike path, pointing to their role in strengthening dollar. It is unlikely that the difference in Trump and the Fed stances, will affect the latter, given that low rates in the current state of the labor market with a record low unemployment can cause it to overheat. The president casually noted that “the yuan falls like a rock” hinting at possible manipulation by the Chinese government. We should expect for the October report “Macroeconomic and FX policies of the main US trading partners,” which will give Trump a formal opportunity to accuse China of currency manipulation and increase pressure on it. On the other hand, if the president intends to include in the arsenal of struggle with China a devaluation tool, the consequences can be unpredictable.
The impressive difference between the Fed and other major Central Banks in relation to the pace of policy normalization is now the main ingredient in the success of the dollar over other major currencies.
The British pound continued its decline yesterday, touching the level of 1.2950. Further drops were restricted by Trump’s comments and an excellent chance for bulls to catch a short-term rebound from powerful support levels below 1.30. But we expect the pair to renew declines especially after today’s data on GDP, Consumption and U. of Michigan consumer optimism data.
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