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US Dollar May Rise vs. Yuan as China Worries Mount: Q4 Top Trades

US Dollar May Rise vs. Yuan as China Worries Mount: Q4 Top Trades

Ilya Spivak, Head Strategist, APAC

US DOLLAR, CHINESE YUAN, USD/CNH – Q4 TOP TRADES

  • US Dollar may reverse downtrend vs. Yuan as China outlook darkens
  • Beijing juggling slowing economy, financial stress and testy geopolitics
  • Head and Shoulders setup at key support may mark USD/CNH bottom
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An increasingly troubling economic and geopolitical backdrop in China may see the Yuan reverse its spirited uptrend against the US Dollar. The currency tellingly rose alongside global shares amid the market-wide recovery from peak-panic lows at the onset of the Covid-19 pandemic in early 2020.

That isn’t surprising: China’s economy is highly geared to the global business cycle, so it seems sensible that it would attract capital flows pouring out of the safety of the US Dollar’s boundless liquidity and searching for returns. A change in course may now be afoot.

Official and private-sector PMI surveys agree that the post-Covid recovery in Chinese growth peaked in November 2020. Performance has deteriorated since, with steady slowdown along the way to a contraction in manufacturing- and service-sector activity recorded in August.

The downturn has put pressure on financial stability. Credit spreads began to rapidly deteriorate in June. They are now nearly back to the strained funding conditions of March 2020, when worries about the pandemic seemed most acute. That property giant Evergrande suddenly seemed to be on the verge of default in September is a case in point.

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Economic troubles have come alongside a sterner posture from Beijing. A thaw in US-China relations does not seem to have materialized with the ascent of the Biden administration in Washington DC following a tense four years under the leadership of Donald Trump. Frictions with Europe, Japan and Australia – among others – continue to simmer.

Meanwhile, Chinese officials have taken a pointedly harder regulatory line, moving with particular zeal to clip the wings of ascendant technology companies and their high-profile bosses. That along with a seemingly tightening mainland grip on Hong Kong has spooked investors and local shares have duly dropped.

Inconveniently for China’s policymakers, the economic soft patch has been hit just as the Federal Reserve begins to lay the foundation for tapering expansive monetary stimulus. That portends a global upshift in borrowing costs ahead. Vast parts of a massive fiscal backstop for the Covid-struck economy are also nearing expiry.

This reflects relative US economic strength. While activity growth has slowed since peaking in May 2021, the pace of nonfarm expansion remains well above the average in recent history. It also amounts to stronger headwinds for China’s economy just as it can ill afford them.

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USD/CNH Technical Analysis

One way to trade this narrative is via an upturn in USD/CNH, the US unit’s pairing against the free-floating “offshore” version of the the Chinese Yuan (as opposed ot CNY, the heavily managed “onshore”expression of China’s currency). Prices may be bottoming as a bullish Head and Shoulders pattern emerges at trend support dating back to early 2014.

Overcoming initial swing-high resistance levels at 6.5285 and 6.5876 may amount to confirmation of reversal, setting the stage for a push higher to challenge the inflection zone capped near the 6.70 figure. This has been pivotal barrier since 2015, with a break above it conjuring up visions of long-lasting USD appreciation.

USD/CNH weekly chart

USD/CNH weekly chart created with TradingView, prepared by Ilya Spivak

--- Written by Ilya Spivak, Head of Greater Asia at DailyFX

Contact Ilya via @IlyaSpivak on Twitter

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