China on the warpath (currency war, that is) ? Or just plain common sense ?

Monday 14th December 2015

China on the warpath (currency war, that is) ? Or just plain common sense ?

Ref : "Investors fear new currency war after renminbi switch" , FT Weekend p.7

Ref : "Yuan Declines to 4yr Low as New Index Signals Weakness" , Bloomberg Markets

When it comes to the latest development regarding the level of China's Yuan / Renminbi, we've yet to hear the views of one particular, curiously-tonsured US presidential hopeful. Of course, he's got his hands full at the moment but will no doubt get around to letting fly before too long. No matter, there'll be plenty of other US politicians from  both sides of the political divide (but sharing a protectionist bent) who'll be happy to condemn the People's Bank of China's latest move as part of a long-running conspiracy to massage the Yuan lower and continue along the path to a damaging currency war.

Late on Friday, the PBOC announced that the value of the Yuan should no longer be measured by its level against the US Dollar alone, but should reflect the wider picture of global trade and investment and take into account fluctuations against a basket of currencies. To that end, the PBOC's China Foreign Exchange Trade System is to publish a new Yuan index composed of 13 currencies, of which the US$ will make up 26.4%.

China's currency may have dropped 3.9% against the Dollar this year, but has appreciated against 12 of 16 major currencies. Plainly, any move to value the Yuan by this broader measure opens up the likelihood that the PBOC will allow weaker fixings. Since they have lowered the reference rate on 8 out of the 10 days since the Yuan gained Reserve Currency status at the IMF, the PBOC stand accused in some quarters of letting the rate slide now that particular goal has been achieved  --  a worry that we've talked about before and one given further traction by this development.

On the face of it, changing the method of valuing your unit of currency to more accurately incorporate broader issues of trade and investment does not seem unreasonable, though no doubt some will see darker motivations behind it. The curious thing is that it has not so far caused analysts to re-appraise their long-term forecasts for US$/Yuan, so maybe the detractors will be just barking at the moon anyway. If there has been one thing that (almost) all agree on, it's that the Yuan will be weaker against the US$ in a year's time, it's just a question of how much. We've looked at a few estimates recently, which have ranged from 6.50 (almost there already) to 7.50 from one major Japanese bank.

Whatever your view, falls in the value of the exchange rate will not be unwelcome for the PBOC and any interventions , diplomatically motivated or otherwise, will more than likely be intended to smooth market moves rather than reverse them. What will be getting their attention however is the fact that the spread between the offshore Hong Kong rate (6.55) and the official onshore rate (6.46) has widened out to 900 pips. This is hardly a ringing recommendation for a currency that has just gained its new elevated status at the IMF. 

Fed Update : It's just not possible ..... is it ?

Ref : General

Wednesday's the day, of course ..... and you've got to believe that the US Fed are finally going to get this rate hike done, surely ? Well not everyone thinks that way, apparently. News this morning that the probability of a hike as defined by Fed Funds Futures markets is back down to 74% (from about 80% at peak). The reasons given ? Falling stock markets, junk bond markets and commodity prices are beginning to replicate the conditions that caused the Fed to delay a move in September, and the renewed down-leg in oil markets in particular mean that inflation pressures are as far away as ever.

This of course ignores the labour market element of inflation that the Fed watches so closely, and the fact that it is not their job to support asset prices. Never mind, we'll let those go for now. There's one other, none-too-scientific but crucial factor to take into account. You'll have to excuse us ..... we've said it before (many times) but we'll say it again :

If the Fed do NOT raise rates on Dec 16th, their credibility will be shot , kaput, beyond redemption .....

To our eyes the opportunity to get this done and out of the way is irresistible (and incidentally may not cause the ructions that some predict), but we have to accept that we could be wrong. In which case we'd look pretty silly, but frankly not as silly as the Fed.