It's not one-way traffic, it hardly ever is .....

 It's not one-way traffic, it hardly ever is .....

ref :- "Dollar Rally stymied by China, Fed as Gold Climbs" , Bloomberg Markets

Look, it's only January 5th and nobody's likely to be readjusting their views just because their favoured play, in this case long US Dollar, is taking a bit of a breather. The US unit has met its first substantial hurdle and it's interesting because inevitably some of the windiest dollar longs will remember only too well what happened to the strong dollar story this time last year (albeit in very different circumstances), and because it involves China. 

It's fair to say that China's actions, words and currency will be under the brightest of spotlights as they come to terms with a new US president who shows no sign of letting up on his anti-China trade rhetoric. His twitter-based interventions on whether the likes of GM and Ford should be basing car production in Mexico suggest that he's highly unlikely to water down his views on China whether they are based on up-to-date facts or not.

But first, let's get this Fed thing out of the way. Yesterday saw the release of the minutes of the Fed's December meeting at which they decided to raise rates by 25 basis points. Some of the mainstream media this morning focused on the fact that the Fed discussed how Donald Trump's fiscal stimulus would inject more heat into the economy  --  the implication being that the Fed would have to be ready to raise rates at an even faster pace. This was a slightly naive interpretation of the minutes. The Fed's thinking on that has been clear since the release of the dot-plot in December : three 25bp hikes in 2017 which is well-known and already largely in the price. In fact, the market preferred to concentrate on the Fed's reiteration of a "gradual" pace of rate rises. Against a background of growing doubts as to whether Mr Trump's boost to fiscal spending will actually achieve the spectacular growth (and attendant inflation) that he desires, the minutes were taken as mildly dollar bearish.

But back to China ..... and in this case it's more instructive to look at the action in US Dollar -v- Offshore Chinese Yuan/Renmimbi (USD / CNH) than against its onshore counterpart (CNY). The onshore yuan can only move 2% up or down from its daily fixed rate, and consequently has not been able to mirror the spectacular moves in USD / CNH which can move freely (after a fashion). If you take a rate of about 6.77 at the time of the US election, less than two days ago USD / CNH traded above 6.98  --  a fall in the value of the Chinese currency no larger than many others against a rampant dollar but very close to the psychologically crucial 7.00 level. Today it traded below 6.84, a record 2-day move.

Contrary to what you might believe listening to Mr Trump (who would have had a point in the early 2000's) , China does spend to protect its currency  --  a lot. FX market intervention on its behalf explains an almost $1 trillion fall in foreign exchange reserves. You might argue that it has not been terribly successful --  Mr Trump certainly would. But quite apart from the question of whether the Yuan is weaker than it should be or whether it's just a case of all-round dollar strength, the Chinese authorities have more than one string to their bow and have been prepared to use them as that 7.00 level approaches dangerously close.

Chinese policy makers are "encouraging" state-owned enterprises to sell their foreign currency and repatriate balances before the Chinese Lunar New Year. They are placing tighter scrutiny on citizens' conversion quotas and are implementing stricter requirements for banks reporting cross-border transactions. Most importantly right now, the measures have severely restricted the ability to convert onshore Yuan to offshore and engineered a shortage of liquidity in the offshore unit. This has forced overnight borrowing rates in Hong Kong as high as 100% (closed at 80%).

Ask a carry trader .... the currency is just too expensive to sell when conditions are that tight.

For now, that is. China's desire to halt capital outflows is not in doubt but that does not mean that they're going to stop, especially if the Dollar should resume its wider upward march. The Hong Kong Monetary Authority may act to inject a supply of currency  --  funding costs at that level for any length of time are decidedly unhealthy. In short, the strong dollar trend could reassert itself in a heartbeat.

One more thing ......

Paradoxically, Donald Trump's attitude to China and its unfairly weak currency (as he sees it) is only serving to undermine the Yuan's value. We wonder if that particular irony might be lost on the new president if he really vents his spleen after inauguration.