CURRENCY TRADE
Macroscope
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Why the yuan’s rise against the dollar is far from over

PUBLISHED : Tuesday, 01 August, 2017, 10:59am
UPDATED : Tuesday, 01 August, 2017, 10:34pm

The US dollar’s recent fall from grace with investors has been most visible in its slide against the euro.

And if its weakness persists, perhaps investors will be drawn again to the Chinese yuan. In fact renminbi strength might not solely be a function of greenback weakness. The yuan can currently stand on its own merits.

Given the euro has risen partly on better euro zone economic data, might not the yuan respond similarly to China’s current growth rate?

But before turning to the yuan, there’s the continuing saga of the American currency’s weakness.

Investors’ faith in the dollar-positive characteristics of the reflationary agenda embedded in President Trump’s election platform has ebbed. Congress has failed to pass legislation that would give momentum to this agenda while the White House has given the impression of dysfunctionality.

The greenback has become a forlorn sight on the foreign exchanges and some, such as Japan’s MUFG, can now see new pitfalls for the currency.

“We suspect once the markets return from the summer break in August,” the Japanese bank wrote last week, “the focus will quickly be on a potential crisis relating to the debt ceiling with the Congressional Budget Office now predicting mid-October as the final deadline for raising the ceiling.”

As for here and now, it’s hard to deny that investors have looked for reasons to sell the greenback rather than ones to buy it.

The currency market sold the dollar versus the euro after the recent European Central Bank meeting even though it didn’t result in a tightening of monetary policy settings. Market participants then sold the greenback after last week’s Federal Reserve policy meeting even though the Fed arguably brought forward tighter US monetary conditions, stating that balance sheet reduction will start “relatively soon.”

As US bank BNYMellon wrote last Friday, “the market is proving selective in its hearing of what central bankers have to say” and currently that’s bad news for the greenback.

But enough of the US dollar; what of China and the yuan?

First off, there’s the fact that next year Morgan Stanley Capital International (MSCI) has said that China’s A shares will be included in the MSCI Emerging Market index. Occurring in two stages, in May and August, the shares will represent a total weight in the index of 0.73 per cent.

HSBC calculated in June that “approximately US$18bn of inflows should arise before the actual inclusion dates next year,” and while that may only be a small tailwind for yuan strength, given that “US$18bn is not large compared to the size of other gross flows in China’s balance of payments,” it is nevertheless a tailwind.

MSCI’s A-share nod brings Chinese stocks into the global mainstream

Additionally, as London-based Eurizon SLJ Macro pointed out last week, “at the growth pace we witnessed in [the first half of 2017] (6.9 per cent in real terms, and close to 9.5 per cent in nominal terms), China is contributing a little more than US$1 trillion in nominal GDP this year, equivalent to the sum of the incremental nominal GDP growth of the US and Euroland.”

Given the euro has risen partly on better euro zone economic data, might not the yuan respond similarly to China’s current growth rate?

Meanwhile if the euro continues to rise versus the US dollar, taking the euro/yuan up in its wake, currency markets might logically conclude the greenback should fall against the renminbi given that China targets the yuan’s value against a basket of currencies and given that, in coming months, Beijing will surely wish to maintain the renminbi’s stability ahead of this year’s keynote Party Congress.

Investors may also note that, and react to the fact that, on the sell side, institutions that have been bearish on the yuan are paring back the extent of their bearishness if not, as yet, becoming bullish.

Italy’s UniCredit Bank believes China’s “strategy of tightening capital controls is linked to a campaign to de-leverage the economy and, for this, keeping capital at home is essential.” UniCredit has revised its “USD-CNY forecast to 6.85 for end-2017,” down from 7.00.

Bank of America Merrill Lynch has revised its own forecast for dollar/yuan to 6.70 at the end of the third quarter of 2017 from 6.95 while early in July, Morgan Stanley saw a risk that the yuan “could be stronger than [its] base case year-end target of 6.90.”

While it would be unrealistic to expect institutions to just flip-flop from being yuan bears to bulls, it’s their change of tone and direction of travel that might attract investors’ attention.

Investors may conclude that when it comes to the prospect of further US dollar depreciation against the yuan, the buck may not stop here.

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