Emerging Market FX: USDCNY Fundamental & Technical Set Up

USDCNY Chinese Yuan

The Chinese Yuan Renminbi is the official currency of the People’s Republic of China. The Yuan (CNY) is the domestic currency used on the mainland of China ex Hong Kong.

The Chinese economy has exploded in the last decade to become the second-largest industrial economy in the world. China is now the leading exporter on the world stage and the second largest import economy. The Chinese economy predominantly comprises of industry and services sectors. From the vast industrial economy comes the by-product of also being one of the largest consumers of commodities in the world.

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Devaluation Disturbance

In August this year, the PBOC took the unprecedented move of following most major developed Central Banks and actively intervening in the FX markets to devalue the Yuan against the USD.

The PBOC took this action to halt the massive depreciation witnessed in the Yuan seeking to keep the Yuan pegged to an unofficial 6.36 level. To achieve this stability, the Central Bank and its market conduits sold CNY723.8Bln worth of reserves in the final weeks of August. This move  represented the largest FX reserve liquidation in history. The Bank also augmented administrative measures as they announced a 20% reserve requirement for forward fx transactions including swaps and options, in a move to discourage speculative bets against Yuan depreciation.

The PBOC are ultimately seeking to stabilise the spread between the onshore and offshore currency to protect purchasing power. This is a move that has been necessitated by most Emerging Market Central Banks to defend against a dramatic depreciation of domestic FX. The action taken by the PBOC has narrowed the spread between USDCHN and USDCNY from 800 to around 300pips since their initial intervention.

Market rumors that the US are supportive of the idea of including the Yuan in the IMF SDR basket of currencies has added further support to the bullish Yuan story. The IMF’s recent visit to China also provides further credence to the SDP inclusion story; the staff completed a two week visit culminating in a statement that encouraged a move toward a floating currency within the next two to three years.

A Chinese QE?..Not so fast

The PBOC announced over the weekend that its is expanding a pilot program in which it is increasing the assets eligible for re-lending to include a further nine cities. The collateral will be rated and assessed by the PBOC for both the assets and the banks. The operation involves taking qualified loans as collateral extending funding to the banks for re-lending in a mechanism similar to debt factoring. This move marks a further development of the PBOC’s liquidity toolkit from previously higher collateral government bonds to corporate loans on bank books.

Market commentators are keen to highlight how this move by the PBOC has striking similarities to the expansionary polices enacted in the US, Europe and Japan. However when examined at a more granular level these similarities dissipate.

In point of fact the latest action by the PBOC is more akin to but necessarily the same as the LTRO (Long Term Financing Operations) enacted by the ECB. Obviously to match the ECB model, requires a predefined scale of enactment and length of implementation to meet the definition of a large scale asset purchase program. The PBOC policy has neither requirements. Primarily the PBOC move is aimed at M2 money supply based on published targets. Secondarily the PBOC preferred mechanism for QE style intervention has and will likely be enacted via and RRR(Reserve Ratio Requirement) cut, which facilitates broad-based liquidity provision. At this point it really isn’t apparent the Chinese banking system is facing an impending liquidity squeeze as the ECB was batting post-2011 crisis.

Now we have a broad understanding of the fundamental drivers in play lets jump into the technical factors moving the charts

Technical Takeaway

The recent action by the PBOC has seen the USDCNY retreat from recent highs but as you can see from the chart below, post the initial stark decline we are now moving within a relatively well defined channel. Moving back to test the prior resistance and support, which from a technical perspective can be seen as a base retest.

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Trading Takeaway

  • I would view any further decline towards the 6.30/6.29 levels as an opportunity to venture long leaning against the previous double top at 6.28 targeting a correction to the recent decline back towards the 6.37/39 zone initially. Obviously this trade has the potential to benefit significantly from a FED move but I would caution against hold the position to long post such an event as we likely witness counter measure by the PBOC in quick order