Fed keeps the risk trade party going

November 17, 2009 — Mitul Kotecha

Risk is back on and the liquidity taps are flowing. Fed Chairman Bernanke noted that it is “not obvious” that US asset prices are out of line with underlying values, comments that were echoed by Fed Vice Chairman Kohn, effectively giving the green light to a further run up in risk trades. The last thing the Fed wants to do is ruin a good party and the comments indicate that the surge in equities over recent months will not be hit by a reversal in monetary policy any time soon.  

Aside from comments by Fed officials risk appetite was also boosted by a stronger than forecast rise in US October retail sales, with US markets choosing to ignore the sharp downward revision to the previous month’s sales, the weaker than forecast ex-autos reading and a surprisingly large drop in the Empire manufacturing survey in November.

Fed comments were not just focussed on the economy and equity markets as Bernanke also tried to boost confidence in the beleaguered USD, highlighting that the Fed is “attentive” to developments in the currency.  He added that the Fed will help ensure that the USD is “strong and a source of global financial stability”.  The comments had a brief impact on the USD and may have given it some support but this is likely to prove short lived. 

The reality is that the Fed is probably quite comfortable with a weak USD given the positive impact on the economy and lack of associated inflation pressures and markets are unlikely to take the Fed’s USD comments too seriously unless there is a real threat of the US authorities doing something to arrest the decline in the USD, a threat which has an extremely low probability.

It is perhaps no coincidence that the Fed is attempting to talk up the USD at the same time that US President Obama meets with Chinese officials.  The comments pre-empt a likely push by China for the US not to implement policies that will undermine the value of the USD but comments by Obama appear to be fairly benign, with the President noting that the US welcomes China’s move to a “more market based currency over time”. The relatively soft tone of these comments will further dampen expectations of an imminent revaluation of the CNY.

Posted in Asia, central banks, China, Currencies, Economics, Economy, equity markets, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , . Leave a Comment »

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 »

CNY appreciation speculation hits EUR

November 12, 2009 — Mitul Kotecha

The USD index is trading close to a 15-month low and direction remains firmly downwards as risk appetite continues to improve and the USD’s status as a funding currency remains unaltered.   Whether it’s a weak USD driving stocks higher or vice-versa, US stocks are currently trading at 13-month highs, maintaining the negative correlation with the USD index. 

One currency that has failed to take advantage of the weak USD over recent days is EUR/USD and its failure to make a sustainable break above 1.50 highlights that momentum in the currency is fading.  EUR/USD looks vulnerable on the downside in the short term, with resistance seen around 1.5050.  Speculation that China will resume CNY appreciation has taken some of the steam out of the EUR given that it implies less recycling of intervention flows into the currency.  

The speculation that China will allow a stronger CNY follows a significant change by China’s central bank, the PBOC to its stated FX policy. The Bank removed the statement  that it will keep the CNY “basically stable” and noted instead that foreign exchange policy would take into account “capital flows and major currency movements”.   

Although this does not mean the CNY will immediately strengthen it will add to speculation that China will allow some appreciation next year following a long stretch in which the CNY has effectively been stuck in a very tight range against the USD.   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.  

Any change in stance on the CNY could be a significant factor in determining the direction for the EUR given that it not only implies less flows into EUR from China but also from other central banks in Asia which may take China’s cue and allow greater strengthening of their currencies versus USD.  Given that central banks in Asia had been intervening to prevent local currency strength and then recycling this USD buying into other currencies, especially EURs, the change in stance could play negatively for the EUR. 

Currencies are also a focus of the APEC meeting of finance ministers, with the draft statement agreeing that flexible exchange rates and interest rates are critical in obtaining balanced and sustainable growth.  This has interesting implications given the FX intervention by Asian central banks to prevent their respective currencies from strengthening and attention will focus squarely on China’s CNY policy.

Posted in Asia, central banks, China, Currencies, emerging markets, FX, US. Tags: , , , , , , , , , , , , , , , . 1 Comment »

Are foreign investors really turning away from US debt?

May 29, 2009 — Mitul Kotecha

The press has been full of stories about the dangers to US credit ratings and growing concerns by foreign official investors about the value of their holdings of US Treasury bonds.   A combination of concerns about the rising US fiscal deficit, Fed quantitative easing and potential monetization of US debt, have accumulated to fuel such fears. Given the symbiotic relationship between China and the US it is perhaps unsurprising that China has been one of the most vocal critics. I have highlighted this in past posts, especially related to the risks to the US dollar. Please refer to US dolllar beaten by the bears and US dolllar under pressure. However, my concerns that foreign investors have been shunning US Treasuries recently may have proved somewhat premature.

Should China or other large reserves holders pull out of US asset markets, it would imply a sharp rise in US bond yields and a much weaker dollar.  However, it is not easy for China or any other central bank to act on such concerns.  China is faced with a “dollar trap” in that any decline in their buying of US Treasuries would undoubtedly reduce the value of their existing Treasury holdings as well as drive up the value of the Chinese yuan as the dollar weakens.  Such a self defeating policy would clearly be unwelcome. 

One solution that China has proposed to reduce the global reliance on the dollar and in turn US assets was to make greater use of Special Drawing Rights (SDRs) which I discussed in a previous post, but in reality this would be fraught with technical difficulties and would in any case take years to achieve.  Nor will it be quick or easy for China to persuade other countries to make more use of the yuan in the place of the dollar.  The first problem in doing so is that fact that the yuan is not a convertible currency and therefore foreign holders would have difficulties in doing much with the currency.  

Foreign official concerns are understandable but whether this translates into a major drop in buying of US Treasuries is another issue all together.  Foreign countries have been gradually reducing their share of dollars in foreign exchange reserves over a period of years.  This is supported by IMF data which shows that dollar holdings in the composition of foreign exchange reserves have fallen from over 70% in 1999 to around 64% at the end of last year.

In contrast the share of euro in global foreign exchange reserves has increased to 27% from 18% over the same period.  This process of diversification likely reflects the growing importance of other major currencies in terms of trade and capital flows, especially the euro, but the pace of diversification can hardly be labeled as rapid. 

Importantly, there is no sign that there has been an acceleration of diversification over recent weeks or months.  Fed custody holdings for foreign official investors have held up well.  In fact, these holdings have actually increased over recent weeks.  Moreover, the share of indirect bids (foreign official participation) in US Treasury auctions have been strong over recent weeks.  Taken together it provides yet more evidence that foreign official investors haven’t shifted away from US bonds despite all the rhetoric. 

Posted in Asia, Bond markets, central banks, China, Currencies, Economics, Economy, Europe, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , . 5 Comments »
Newer posts »