Emerging Market FX: RRR Cut To Calm Data Concerns

Emerging Market FX: RRR Cut To Calm Data Concerns

Chinese data and policy change over the past 24 hours have been bearish for the CNY and by corrolary bullish USD-Asia. Today’s weak February PMIs are the clearer problem, but the reserve requirement cut could potentially also work to weaken the yuan.

The implication of yesterday’s 50bps reserve requirement cut for the CNY exchange rate will depend on whether it translates into a monetary ease that lowers China’s interest rate structure or just a restructuring of the PBOC’s liquidity provision to banks. Market expectations for broad USD strength have almost certainly been a key driver of the emergence of expectations for CNY depreciation over the past year. However as the PBOC has lowered yields in response to weaker Chinese growth, lower relative returns have contributed to capital outflows from China.
The RRR cut is mainly a restructuring of how it provides liquidity rather than a net liquidity injection. The August and October RRR cuts came with cuts of administered rates, but neither of lowered the 7-day repo rate. Nonetheless, to the extent that cuts in the RRR reduce implict taxation of the banks, they reduce cost of funds and may contribute to lower rates in general. This may have contributed to the falls in onshore swap rates and returns to bank wealth management products, the latter from 4.7% in July last year to 4.1% recently, in the wake of ending of administrative control over deposit rates.

Today’s release of weaker-than-expected PMIs for February to be the more bearish indicator for the CNY and EM Asia currencies more generally. Two main points stand out:

  1. Slowing Chinese growth has been a core driver of expectations for CNY depreciation and today’s PMIs reinforce our view that GDP growth is on track to slow to just above 6%qoq as in Q1. A particular concern is that the continued weakening in the PMIs suggest that central government efforts to support growth through fiscal spending are not fully offsetting the drag from weakness in housing construction and heavy industry.
  2. Slower Chinese growth is bearish for Asian FX even if the Chinese authorities restrict CNY depreciation in the short term. Weaker Chinese growth is likely to lead to additional capital outflows from Asia as the negative implications for Asian growth lead to equity market weakness and expectations for further monetary policy easing across the region.

Against this background, the path of the USD is a key risk. Recent stability in USDCNY has come in large part from USD weakness against the major currencies. If the combination of new ECB monetary stimulus and stronger US data push the USD meaningfully stronger, it would likely rekindle capital outflows from China by forcing USDCNY fixes higher.

Technical & Trading Takeaways

I believe there will be an excellent risk reward with trend entry as price retests former spike highs and ascending channel support at the the 6.4700/6.4500 level where I would be watching for intraday reversal patterns to venture long targeting the topside of the channel. My interest in this trading level has increased with the current price pattern setting up a symmetrical AB=CD decline into the support zone as highlighted in the chart below.


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

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