Is China about to revalue the Yuan?

November 15, 2009 — Mitul Kotecha

Speculation has intensified that China will allow the CNY to resume appreciation. As well as a move in USD/CNY NDFs, implied options volatility has also risen. Speculation of CNY revaluation follows a significant change by China’s central bank, the PBOC to its stated FX policy in its quarterly monetary policy report last week.

The timing of the change in rhetoric should come as little surprise as it coincides with greater international calls for a stronger CNY to help rebalance the global economy as well as an improvement in economic data domestically. China has so far resisted such calls but the time may now be right for China to play its part in the global rebalancing process.

Recall that China had allowed a close to 20% appreciation of the CNY between July 2005 and July 2008 but re-pegged to the USD as the financial crisis intensified. This policy proved to be the correct one during the crisis as a stable versus appreciating exchange rate not only helped exports but helped contribute to China’s economic resilience during the crisis.

Now however, this policy is no longer needed. The worst of the crisis is over and China’s economy is doing remarkably well. Keeping the CNY artificially undervalued may stoke potential inflationary problems and distort the recovery process, whilst limiting the shift to a more consumer based economy. Managing China’s massive $2 trillion + of exchange reserves is becoming a more complicated and difficult process too. Moreover, the undervalued CNY is proving to be a global problem and hindering the adjustment of global imbalances.

Will there be an imminent revaluation of the CNY? China is in no rush to see the CNY appreciate and is unlikely to act when US President Obama is visiting. If anything, the Chinese authorities will renew the CNY appreciation trend when there is less political pressure as the last thing they want to do is to appear to be bowing to US or international pressure.

Yes the CNY is undervalued and the Chinese know this well. What is different this time is that the rest of Asia wants China to move and this is sufficient for China to act eventually but not imminently. The Chinese authorities are concerned about hot money flows and do not want to give the impression that they are embarking on an aggressive revaluation path. Gradual is the way to go but there is still room for markets to price in more appreciation next year.

What will happen during Obama’s visit is that the Chinese delegation will push for the US not to implement policies that will undermine the value of the USD especially in relation to the US fiscal deficit and the burgeoning Fed balance sheet. In return the US will push China into allowing the CNY to strengthen.

China appears to be in a stronger bargaining position given that China remains the biggest buyer of US Treasuries and the US will do little to jeopardise these investment flows. Perhaps China has pre-empted the US calls for a stronger CNY by changing the language in its monetary policy statement and it was likely no coincidence that the change happened just ahead of the US visit.

Posted in Asia, central banks, China, Currencies, Economics, emerging markets, FX, US. Tags: , , , , , , , , , . 2 Comments »

Searching for inspiration

November 9, 2009 — Mitul Kotecha

After an eventful week which included several central bank meetings and the US Jobs report there is less for markets to get their teeth into this week.  Despite the weak US jobs report risk appetite looks relatively resilient suggesting that the USD will struggle to make much headway over coming days.  

Despite all of the events last week markets have been uninspired.  Even the G20 meeting delivered little to be excited about with no further developments on how to rebalance the global economy and the USD’s role in the process.  The lack of attention on the USD will leave it with little directional influence this week, with equity markets likely to the main driver once again.

One currency that may look a little better supported over coming days is the EUR.  GDP data later in the week is likely to reveal an expansion over Q3 after several quarters of contraction as indicated by various PMI data. Although it will likely be led by inventories and exports rather than domestic demand it will nonetheless come as good news, albeit backward looking.  Going forward growth in Europe is unlikely to match the pace of recovery in the US but for now the GDP data will be EUR supportive helping EUR/USD to gravitate around 1.50 and beyond. 

Meanwhile, central banks may also do their part in influencing currencies given their differing stances on monetary policy.  Although the Fed did not deliver any big surprises last week the FOMC statement will play for a softer USD as the currency looks to maintain its funding currency status for an “extended period”.   In contrast the RBA hiked rates as expected and despite hinting at more gradual rate increases in the months ahead the AUD continues to stand to benefit.   Going in the opposite direction the BoE increased its asset purchases but GBP avoided a significant negative fall out as the move is likely to be seen as the final step in the BoE’s asset purchase programme.

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US dollar remains funding currency of choice

November 5, 2009 — Mitul Kotecha

Rate hikes in some countries including Australia and Norway and a general improvement in economic data had led to some expectations that the Fed would shift its rhetoric on monetary policy but in the event this was not to be the case.  The key comment in the FOMC statement following the interest rate decision was that rates would be kept low for an “extended period”. The Fed added that its policy stance was contingent on “low rates of resource utilization, subdued inflation trends and stable inflation expectations.”  

The fact that the Fed maintained its relatively dovish stance contrary to some expectations ahead of the FOMC meeting resulted in interest rate markets paring back expectations for future rate hikes though I still believe that a rate hike anytime in 2010 will prove premature.  The Fed’s new conditions mean however, that the Fed will be more restricted when it does come to timing rate hikes and markets will watch closely, the unemployment rate and inflation expectations to determine this timing. 

Given that the unemployment rate is still rising and is expected to decline only slowly over coming months whilst core inflation is set to decline further, and excess slack in the economy is only likely to be reduced gradually, markets are still too aggressive in looking for increases in interest rates next year.  The Fed did not remove the reference to an “extended period” of low rates despite speculation ahead of the meeting and whilst many in the market continue to debate how long this will be, the Fed will not feel any need to rush to reverse policy. 

The USD weakened following the FOMC meeting but did not suffer a particularly hard blow.  Going forward the USD will not recover until there is clearer evidence that the Fed is ready to reverse policy and in the near term this means that the USD will remain under pressure, especially if markets push back expectations of rate hikes.  This will mean that the USD will continue to be the funding currency of choice for several months yet.  Cyclical USD recovery is still some way off but eventually the Fed’s actions will pay off and the USD will recover by around mid 2010 as the market becomes more aggressive in pricing in rate hikes in the US.

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Lots of event risk in the days ahead

November 3, 2009 — Mitul Kotecha

Fears about yet another market crash in October proved unfounded but there were severe bouts of nervousness during parts of the month.  This was hard to tie in with the strength of earnings and continued good news on the economic front but perhaps markets had already priced in a lot of good news.   This was evident in the fact that economic surprises were becoming increasingly negative.

Nervousness is good for the dollar and has at least given the currency a semblance of support.   However, not all the economic news is coming in below forecast as demonstrated by the stronger than consensus reading for the US ISM index for October whilst even the eurozone PMI moved back into expansion territory following 17 months of contraction.

The tone over the rest of the week will depend on the outcome of several central bank meetings the main ones being the Fed, ECB and BoE as well as the US non-farm payrolls report.  None of the central banks are likely to hike rates but in an FX market that is becoming increasingly reactive to interest rate differentials whichever bank sounds relatively more hawkish will see their respective currency strengthen the most.

Unless the Fed sounds particularly dovish the dollar is likely to consolidate further over the short term and given the still significant size of dollar short positioning there is still some scope for some further relief for the dollar.   However, don’t expect much movement out of current ranges until after the payrolls report and even then markets may be hesitant ahead of this weekend’s G20 meeting.

Posted in central banks, Currencies, Economics, Economy, equity markets, Europe, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , . 1 Comment »

Contemplating Rate Hikes

October 28, 2009 — Mitul Kotecha

The market mood has definitely soured and risk appetite has faltered.  This is good for the USD but bad for relatively high yielding/commodity risk trades. The USD is set to retain a firm tone over the near term even if is temporary, which I believe it is.  

Whether it’s profit taking on crowded risk trades, a lot of good news having already been priced in, fears that other countries will follow Brazil’s example of taxing capital inflows to dampen currency strength, or a reaction to weaker economic data, it is clear that there are many reasons to be cautious. 

It is also unlikely to be coincidental that the rise in risk aversion and drop in equity markets is happening at a time when many central banks are contemplating exit strategies and when many investors are pondering the timing of interest rates hikes globally following the moves by Australia and Israel. 

One of the reasons for the worsening in market mood is that some parts of the global economy may not be ready for rate hikes.  Certainly there is little chance of a US rate hike on the horizon and perhaps not until 2011 given the prospects of a sub par economic recovery.  This projection was given support by the surprise drop in US consumer confidence in October.

It is not just the US that is unlikely to see a quick reversal in monetary policy.  As indicated by the bigger than expected decline in annual M3 money supply growth in the eurozone, which hit its lowest level since the series began in 1980, as well as the drop in bank loans to the private sector, the ECB will be in no hurry to wind down its non-standard monetary policy measures. 

The chances of any shift in policy at next week’s ECB meeting are minimal, with the ECB’s cautious stance emboldened by the subdued money supply and credit data.  As long as EUR/USD remains below 1.50 ECB President Trichet is also unlikely to step up his rhetoric on the strength of the EUR.  

Although the major economies of US, Eurozone, Japan and UK are likely to maintain current policies for a long while yet, the stance is not shared elsewhere.  The Reserve Bank of India did not raise interest rates following its meeting this week but edged in this direction by requiring banks to buy more T-bills. Other central banks in the region are set to move in this direction.

In terms of developed economies, Norway was the latest to join the club hiking rates by 25bps and adding to the growing list of countries starting the process of policy normalisation.   Australia is set to hike rates again at next week’s meeting although a 50bps hike looks unlikely, with a 25bps move more likely. 

Posted in Asia, Bond markets, central banks, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, India, Interest rates, Japan, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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