BNY Mellon: An Odd Picture for the CNY

October 19, 2018

By Simon Derrick, Chief Currency Strategist, BNY Mellon

While it’s true that the CNY basket has remained relatively stable over the past few days (albeit still hovering just below the 2017 lows), the combination of Fed minutes, the failure of the US Treasury to call China a currency manipulator and fresh multi-year lows for the CSI 300, provided the catalyst for the currency to trade to its weakest level against the USD since the start of 2017 during trading yesterday.

What is curious, however, is that unlike the period between August 2015 and Jan 2016 or, again, in December 2016, there’s little sign of the NDF market becoming particularly excited about the prospect of a significant move higher in USD/CNY over the next 12 months.

Indeed, to put this into some kind of context, the spread between the one-year NDF forward outright and spot is currently at about the same level as it stood in October 2012 when the USD downtrend was starting to slow (see below).

This suggests that this is a market that collectively believes the PBOC will be able to carry out a very effective smoothing operation in the months ahead and that any move by the USD above CNY 7 will likely prove muted.

While it’s perfectly possible that this will prove the case given that China still holds over USD 3 trn in FX reserves and it’s certainly true that some very clear warnings were sent this summer , this is still curious for a number of reasons. 

Firstly, as noted on a number of occasions, 2015 showed that the use of FX reserves in an aggressive defence of a currency is not without risk.

Secondly, this summer showed very clearly that there are points when the authorities are prepared to let the currency take the strain.

What is equally odd is that there is some tangential evidence that China is the issue weighing on sentiment right now. The first point to note is quite how risk sentiment has varied on a regional basis over the course of this week.

This can be clearly seen in the performance of the JPY, which was bid throughout the Asian trading sessions on Monday, Wednesday and Thursday but remained largely offered (at least up until the sharp sell off seen in US equity indices yesterday).

This is also evident in the relatively poor performance of both the CNY and a number of regional currencies in recent weeks (including the KRW and TWD) when compared to that of a number of other currencies (notably the BRL, TRY and ZAR) that were seen as being in or on the verge of crisis less than two months ago.

This adds up to an odd picture. On the one hand there appears to be little evidence of investors expecting a significant decline in the CNY in the months ahead.

On the other it’s clear that sentiment in the region remains fragile and that it’s likely connected to China rather than anything else.

As noted last week there appear to be some curious paradoxes growing around China right now.