Since breaking through the $7.0 level in the first week of August, the Chinese yuan has continued to fall in value against the US dollar. The move over $7.0 was psychologically important and politically sensitive. Whereas previous moves have been larger in scale, the sudden shift in the forex rate was something of a half-step. Even those that predicted that the move would continue out to over the $7.10 level and beyond might be surprised at how rapidly the second movement has come about. The USDCNY conversion rate has weakened for nine consecutive days and is now set for the biggest monthly drop on record – all of which proves correct the theory that the PBOC doesn’t do things by halves.
USDCNY – five-day price chart
The five-day price chart highlights the now-familiar movement of the yuan in a sideways pattern that then shifts suddenly, in this instance to higher than $7.10. This kind of price action is proving particularly hard for markets to predict, and while the “fixing” is certainly a major influence on the markets, there is of course a counter argument that long-term investors, at least, need to stop sweating the small stuff.
A nine-day straight run in any market certainly appears counter-intuitive. There’s usually a bounce of some sort, even if it’s of the “dead cat” variety. Even during the crash of 2008-9, the falling markets always found a momentary level of support before realising that they were still horribly overvalued.
The shift underlines the extent to which the rate is managed by the PBOC rather than driven by market forces. There is also the “counter-cyclical” intervention of the PBOC to contend with. The underlying principle, as many understand it, is that the PBOC will try to fight whichever direction market forces are pulling the yuan.
Considering the fix now involves bluff, double bluff and triple bluff, it’s worth considering the words of Burkhard Varnholt, CIO at Credit Suisse, who was speaking with Bloomberg when he tried to approach the matter of the trade war from a different perspective. He said: “This erratic trade war is something we shouldn’t read too much into – the one thing we’ve learned over the last couple of months is that it moves up one day and the other day it moves down. The reality is this is not a trade war, this is a geo-politic rivalry between two great geo-politic and economic powers and it’s going to be with us for the next 5 and 10 years.”
The yuan fixing is one tool of many available to the Chinese administration. It’s now clear that 2019 marks the year that the Chinese administration asserts their right to use it as and when they please. Some might recall that this time last year, analysts were confident that the yuan would be kept out of the trade war. As CNBC reported at the time:
“China’s central bank altered how it manages the country’s currency, showing the yuan won’t be a trade war weapon, analysts say.”
Things have certainly changed. This month’s official protestations by the US to the IMF, which allege that China is a “currency manipulator”, point out the obvious but won’t make the problem go away. The plea to the IMF appears a politically orientated move, and investors would do well to remember that there is a presidential election in the US next year. In a report for the South China Morning Post’s website, Cary Huang wrote:
“A currency war with China could also serve Trump’s domestic agenda, as re-election campaign managers might find it helps unite domestic political alliances across party lines. It comes amid a growing bipartisan belief that it is time to get tough with an increasingly assertive and authoritarian state that is undermining America’s economy.”
Source: South China Morning Post
USDCNY – one-year price chart
The shaded area on the one-year USDCNY price chart shows the total move to represent a 7.17% devaluation. This is a not-insignificant number and illustrates the issue facing US manufacturers that see their Chinese rivals undercut them.
Although the move came in two distinct steps, it was still a much faster shift than those valuations of previous years. The five-year price chart shows the move occurring over weeks, not months. Despite the change taking place at a faster rate, the argument that the PBOC devaluations come in unit size of between 7% and 10% still stands – which, interestingly for investors, means that this current move could still have some way to go.
Stephen Innes, Managing Director at VM Markets Ltd, was speaking of the day-to-day working of the “counter-cyclical” process and its influence on short-term moves when he said:
“It’s clear as day the PBOC are beefing up the counter-cyclical measure to avoid at all cost any negative fallout”from the trade dispute. “It’s also clear that they are not willing to let the yuan depreciate too fast, which is mildly supportive for risk assets. A rapidly depreciating yuan could trigger a wave of capital outflows.”
The extra attention paid to the daily yuan fix highlights for traders that it may be easier to see the longer-term moves than the short-term ones. Analysts are rushing to update their calls on USDCNY and forecast further yuan weakness. Goldman Sachs Group Inc. (NYSE: GS) predicts a drop to $7.2 in three months and Bank of America Merrill Lynch (NYSE: BAC) foresees a decline to $7.5 by year-end. The Goldman Sachs call could possibly be proven correct before the ink on the report dries. Given such uncertainty and short-term “noise”, the approach of Burkhard Varnholt may be the best course of action. Maintaining a positive outlook, he said:
“Investors should remember that they are not investing into geo-politics. We’re investing into businesses and businesses are remarkably adaptable flexible and pragmatic. Business adapts quickly and that bodes well for the way corporate earnings should develop.”