Chinese currency drops sharply

Once again the Chinese currency CNY dropped, this time recording its biggest drop in 2 years. The message is clear China wants to deter hot money inflows ahead of a potential band widening.

Weaker Chinese economic data is also undermining demand for the CNY from exporters while the Chinese authorities want to increase the volatility of the CNY and engineer a degree of two way risk.

Chinese officials have played down the drop in the CNY and CNH but nonetheless, markets are seeing it as a shift in policy following recently weaker economic data. China’s Finance Minister Lou Jiwei noted that that move in the yuan is “within normal range” an indication that officials are not particularly concerned about the currency.

From a technical perspective the move in USD/CNY is significant. The currency pair touched 6.1227, breaching its 200 day moving average around 6.1018. The MACD (moving average convergence/divergence) has turned bullish too although the RSI (relative strength index) suggests that USD/CNY may be overbought.

Overall, expect further CNY weaknes in the short term (next few weeks) but dont expect this it to turn into a long term trend. Eventually CNY will resume an appreciation path assisted by continued strength in the country’s external balance.

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AUD resilient, JPY downside risks

Against the backdrop of concerns about Chinese growth and a weaker path for China’s currency, the AUD has failed to make any headway over recent days. Perhaps more interesting is the fact that AUD remains one of the best performing currencies despite such concerns. From a positioning perspective the market is still net short AUD, albeit less so over recent weeks, implying that there is still scope for short covering.

The rally in commodity prices over recent days will likely have helped the AUD but notably it’s the wrong commodities that are rallying. For instance, iron ore prices have dropped sharply. Nonetheless, improving risk appetite is giving AUD some relief and downside risks to the currency remain limited, with its resilience set to continue. Consequently AUD/USD is set to see strong buying interest on any dip to technical support around 0.927.

USD/JPY has been range bound over recent sessions failing to make any significant headway above the 102.50 level. The consolidation in US Treasury yields is a factor capping gains in USD/JPY but an improvement in risk appetite and gains in Japanese equity markets will likely help fuel some downside risks for JPY over the near term.

There are also signs that after several weeks of net inflows, Japan is finally beginning to register renewed outflows of portfolio capital which ought to add further downward pressure on the JPY. The fact that the speculative market remains net short JPY may limit the pace of JPY depreciation, however. It is difficult to see JPY volatility decline further from already very low levels but a break of current ranges may require a bigger move in US Treasury yields. We remain long USD/JPY at 102.39.

Weak US data overlooked

Although US stocks could not hold onto record highs overnight they still managed to close higher following on from gains in European equity markets. Firmer US equities will give a positive lead to Asian markets today although the gyrations in CNY and CNH will be watched closely. Our risk barometer as well as the VIX ‘fear gauge” indicate that risk appetite is on a positive trend while US Treasuries and the USD consolidate.

Weaker data in the US in the form of the Chicago Fed activity index and Dallas Fed activity index as well the Markit service sector PMI confidence index were shrugged off by the market, with weakness continuing to be attributed to harsh weather conditions. This theory will be tested over coming weeks as weather conditions normalise but for now markets are giving the US economy the benefit of the doubt.

Meanwhile, Eurozone inflation data yesterday highlighted the significant amount of room that the European Central Bank has to ease policy further. On tap today of note is the French INSEE survey and US consumer confidence, both for February and neither of which is likely to prove particularly market moving.

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