Yuan/Dollar: The Only Number That Matters?By admin_45 in Blog
We’re seeing a lot of commentary about the number 7 lately, specifically related to the exchange rate between the US dollar and the Chinese yuan. Some sources are even calling it the most important number for global capital markets just. So let’s talk about it…
- The yuan has weakened versus the dollar by 6.5% since the start of 2018 and 10.1% from its late March high water mark.
- This is greater dollar weakness than that experienced by developed economy currencies. The DXY Dollar Index (mostly the euro, yen, and pound versus the dollar) is +4.5% YTD and 8.7% higher since its February lows.
The number 7:
- The offshore yuan trades for 6.9529 to the dollar just now.
- You have to go back to December 2016 to find equally low levels for the yuan/dollar cross. We were unable to find a time when the yuan ever breached 7/dollar since 2011.
All this matters for 3 reasons:
#1. Trade. The 10% depreciation for the yuan since March largely cancels out the current 10% US tariffs on many Chinese goods in terms of their effect on the country’s exporters. But… these tariffs go to 25% at the end of 2018. A further 15% depreciation in the yuan would certainly exacerbate already parlous relationship between China and the United States. Something global equity markets don’t want to see…
Policymakers at the Central Bank of China were out last week saying they would not use the yuan as a tool to fend off the economics effects of trade disputes. A good piece from the South China Morning Post (link below) explained that the Chinese government “regards the exchange rate not as a normal price indicator but as a symbol of China’s economic health that must be defended.”
#2. Global capital markets volatility. Those of you with long-ish memories will recall that China did allow a surprise 2% devaluation during the local stock market rout of August 2015. Markets around the world took that as a sign of panic on the part of Chinese policymakers, and equities in developed economies plummeted the Monday morning of the move lower for the yuan.
Currency trading data complied by Bloomberg last week shows that dollar-yuan volumes are now higher than that 2015 meltdown. They attribute this to several Chinese banks selling dollars, potentially to defend the yuan. Worth noting: the yuan weakened a further 0.4% over the 2 days after this possible central bank intervention.
#3. The Chinese economy. The SCMP article notes that China saw $500 billion of outflows in 2015 as it weakened its currency from 6.2/dollar to 6.4/dollar. With the currency now 9.4% lower than 2015, and near its 2011-present lows, further outflows from incremental devaluation is a real risk.
All this could not come at a worse time for the Chinese economy, already beset by trade/tariff frictions, frothy real estate markets, and high levels of corporate financial leverage.
Summing up: it is easy to see why so much fast/smart money is focused on the 7 yuan/dollar exchange rate. We’ve mentioned in past notes that the Shanghai Composite is the world’s most important stock market to watch just now, the canary in the coalmine for global equity market sentiment.
Yes, China has the capital to defend the 7 level for now. But how much does it want to, and for how long? Even if your investment bailiwick is small cap US stocks, seemingly distant from this topic, this is an important number to watch.
South China Morning Post article: https://www.scmp.com/economy/china-economy/article/2170395/beijing-will-not-use-yuan-trade-war-weapon-it-hits-two-yearBloomberg article: https://www.bloomberg.com/news/articles/2018-10-24/yuan-trading-volume-exceeds-2015-peak-as-currency-stays-rooted Read more of our content here! Make sure you sign up for a 2-week free trial to one of Wall Street's most followed daily market commentaries below!