Neutralising the Yuan Bomb

Market Analysis /
09 Sep 2019

On August 5, 2019, The People's Bank of China (PBOC) unleashed their version of shock and awe by allowing the natural market's reaction for the Yuan to weaken and move through the psychologically significant 7.0 USDCNY level. However, the destabilising effect of a rapidly weakening Yuan sent a tsunami of risk aversion across global markets, leaving a swath of market carnage in its wake. U.S. equities sustained their most significant decline since December 2018. The S&P 500 plunged 3%, and the Dow Jones Industrial Average lost almost 800 points.

U.S. stocks registered their most significant one-day drop of the year in reaction to the Yuan bomb that with ultra-precision guidance hit flush in the centre of the currency war debate triggering The U.S. Treasury Department to label China, a currency manipulator officially.

While the "currency manipulator tag" is a mostly symbolic gesture, it underscored rising trade tension and increased the likelihood of U.S. Treasury intervention which had traders preparing for worst-case scenarios: a protracted equity market sell-off, lower U.S. bond yields while provoking a stampede into safe havens.

As the Yuan weakened investors flocked into Gold, and the pace accelerated post-August 5

Daily Yuan Fix 9:15 AM Singapore

 

Source: Bloomberg

 

 

"The thought of a currency war is crossing more than a few traders' minds," Stephen Innes AxiTrader APAC strategist (Washington Post) August 5

Back on August 11 in 2015, when we had large CNY and CNH depreciation, the first two days after the adjustment saw the CNY fix track 5 to 6 significant figures below spot, hence the reason for the market tumult.

From August 5 2019 onwards the markets have become absolutely "Fixated” with the daily fix which has been the primary driver of regional currency markets and will remain at the epicentre of both trade and currency war narrative.

Fortunately for risk sentiment after the break of USDCNY 7.0, the PBOC has continued to fix the Yuan stronger than the close, it avoided the worst of market fears and catalysed a mild reversal lower in the USD and recovery in regional risk assets. 

The Yuan outsized  influence on Regional ASEAN currencies

Source: Bloomberg

 

As the Yuan stabilises and gradually starts to strengthen the Shanghai Composite Index sentiment has improved.

Source: Bloomberg

Fast forward to September 10, 2019

 

The PBOC is walking back perceptions of Chinese retaliatory actions through the currency by overtly signalling they have little intention to move forward with competitive devaluation nor weaponising the Yuan as a tariff offset but are willing to tolerate a slight Yuan weakness driven by market forces 

 

It's clear as day the PBOC is beefing up the counter-cyclical measure to avoid at all cost any negative fall out from the U.S. Treasury that they are attempting to weaponise the Yuan as a tariff offset, which is suggesting that Beijing would like to de-escalate trade tensions with Washington.

 

 "It's clear as day the PBOC is beefing up the counter-cyclical measure to avoid at all cost any negative fallout" from the trade dispute, said Stephen Innes AxiTrader APAC strategist (Bloomberg) August 26

 

The PBOC has been setting a stronger-than-expected fixing to stem Yuan weakness.

The gap between the actual fixing and the average Bloomberg and Reuters daily Interbank Trader surveys are at historically high levels suggesting the PBOC is intent to curb Yuan weakness. So, while the market remains bearish, the PBOC is in a more bullish frame of mind.

 

GAP between actual Fix and daily estimates

Source: Bloomberg

With the PBOC fixing CNY stronger than expected daily, it's also apparent that they are not willing to let the Yuan depreciate too fast, which is supporting risk assets. 

However, its also a self-serving policy as the PBOC are nervous that a rapidly depreciating Yuan could trigger a wave of capital outflows.

 

So, what is the counter-cyclical mechanism?

The PBOC adjust the formula for calculating its daily yuan reference rate, to ward off potential capital outflows. 

The formula used to determine the next day's midpoint fixing factors is the Yuan settlement rate against the U.S. dollar at 4:30 p.m. HKT (0830 GMT), along with changes in the trade-weighted basket of currencies and the counter-cyclical factor.

To counter the Yuan weakness at the p.m.4:30 p.m. HKT end of the day reporting period the PBOC effectively sets the Yuan stronger to 1) stem capital outflows 2) to avoid at all cost any negative fall out from the U.S. Treasury that they are attempting to weaponise the Yuan as a tariff offset.

 

Read more market views from Team AxiTrader: https://www.axitrader.com/int/market-news-blog/.

 

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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