Emerging Market FX: RMB Recommended For SDR Inclusion

As we discussed in a segment a few weeks back, the IMF Director Christine Lagarde, has as we suggested proceeded to recommend to the Executive board of the IMF that they include the Chinese RMB in to its Special Drawing Rights basket of reserve currencies.

RMB Recognized As SDR Entrant

Lagarde was supportive of the findings of the exploratory committee whose IMF staff determined that the

Chinese authorities have addressed all remaining operational issues identified in an initial staff analysis submitted to the Executive Board in July

This communication recognizes significant headway that has been made and that inclusion in likely unconditional and imminent. The acceptance has been further supported by US Treasury Secretary Lew, during a conference call with China’s Vice Premier Wang Yang where Lew confirmed that the US would be broadly enthusiastic about the Chinese currency’s inclusion in the basket. This latest testament of support echoes that of other members of the IMF who are also supportive of this development.

Inclusion Implications

With respect to the near term implications of the IMF move it is somewhat unlikely that the RMB is going to experience a rush of capital inflow, as in the near to medium term the inclusion in the SDR is only going to establish transactions between IMF member central banks and wont include open market flows. The closed transactions wont initially be of size to move the dial on a flow basis.

The total size of the SDR to date is circa 280bln USD, so if hypothetically the RMB gets an implied ten percent weighting in the basket ( the exact weighting is still to be confirmed), using the notional ten percent figure that gives a 28bln USD flow, furthermore even once the inclusion is officially confirmed the transactions wont take place until after September 2016.

Another potential issue to consider is the current climate with respect to the global view on the implications of financial challenges the domestic Chinese economy continues to face, the recent precipitous decline in economic data and indicators is likely to impinge upon the appetite of reserve mangers and sovereign wealth funds to initiate significant exposure to RMB denominated assets. Especially while the Peoples Bank Of China (PBOC) are orientated towards continued reduction in the Reserve Ratio Rate, with many market watchers estimating an imminent further move with some also pricing in a  further move before year end. While in the near term the PBOC appear committed to the current course of easing some have ventured that the inclusion in the SDR is the first step in a process whereby the PBOC will begin to withdraw from outright FX intervention leaning toward a more market determined pricing of its currency.

The most likely near term effect of the potential November 30th official announcement of inclusion in the SDR, is that the PBOC may make a concerted push towards converging further the onshore and off shore FX rates. The PBOC has historically posited the importance of creating a single currency rate to better facilitate the inclusion of the RMB in the SDR basket. The current spread as of writing is about 250 pips between offshore USDCNH and the onshore USDCNY it is certainly worth monitoring this spread in the weeks preceding the IMF board meeting. With an official announcement on November 30th the major immediate takeaway from the statement of intent will be official global recognition that China has arrived on the global financial stage and is well on its way to emerging as a dominant powerhouse of the future.

Trading Take Aways

I continue to track the upside channel breach which suggests the potential for the USDCNY correction to be complete. So now I am monitoring the price action looking for a relatively retest of the broken trend line resistance as support.

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So as you can see in the chart above I have identified the trade level of interest 6.3452 and I will monitor this zone on intraday time frames looking for a reversal pattern to venture long, and I will use the low of the day of entry as a protective stop for this position.

Open Emerging Market FX Trades

Long USDINR 65.25 Stops To Entry, First Target Achieved at 66.85, stay long to target a retest and break of year to date highs next

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For updates on trade of the day set ups and the other trades I am currently monitoring be sure to follow me on Twitter @LFXPatrick