By Callum Thomas
Here’s a couple of charts on a topical and divisive subject – the outlook for the Chinese yuan. This is something I’ve spent a lot of time looking at, and have been bearish Renminbi vs US dollar for a few good reasons. Before we look at the charts let’s talk about why. It’s basically 3 reasons, and it’s mostly about the fundamentals: 1. Economic divergence (China’s economy is slowing vs US accelerating); 2. Policy divergence (Fed hiking rates + QT vs PBOC cutting RRR, easing liquidity); 3. Politics (CNY weakness provides a timely offset against tariffs, and eases domestic pressure).
1. Interest Rate Differentials: The first chart maps the USDCNY against monetary policy rate differentials. Interest rate differentials are a fairly well established indicator for exchange rates because they reflect incentives e.g. borrowing in one currency (lower interest rate) and investing in the other (higher interest rate), and also reflect divergences in economic developments and monetary policy cycles. If you take this chart literally the USDCNY could end up going well beyond 7 …on that note, this is basic economics, not competitive devaluation.
Continue reading USDCNY – It’s Going to 7
By Callum Thomas
Well it’s a mouthful of a title, but sometimes you just have to say exactly what’s in the post and today we’re looking at 4 charts-in-one… and they are about as topical as it comes. The charts come from our weekly Global Cross Asset Market Monitor: the top left is the US dollar index, the top right is an equal weighted emerging market currency index (25 currencies vs USD), the bottom left is an equal weighted index of 10 Asian currencies vs the USD, and the bottom right of course is the Renminbi against the US dollar (USDCNY). Bottom line is there is a big move underway across global foreign exchange markets right now, and it’s quite likely there’s more to come.
What’s driving this, aside from a few idiosyncratic issues (e.g. Turkey – which I believe is simply a symptom of a wider issue), is monetary policy divergence, a subtle desynchronization of global growth, and softening macro picture in China. Fed tightening (rate hikes and QT) is a key catalyst, and the trade war just adds fuel to the fire. I talked previously about how Fed tightening and a stronger dollar is going to put stress on emerging markets, and the charts above show basically this thesis in action. The biggest risk is that you get a feedback loop of stronger dollar >> EM stress >> stronger dollar >> and so on. As previously noted, the USDCNY going through 7 could be a critical test (aka nail in the coffin) for the low volatility environment, and as I write the USDCNY is trading just over 6.933, so this test may come sooner than you expect…
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