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China_Weekly_Yuan_in_Focus_After_IMF_and_G7_body_image1.png, China Weekly; Yuan in Focus After IMF and G7.

With its long national holiday now over, China has returned to center stage as comments from European officials last week indicate that pressure is mounting on China to act on the yuan. The pressure heaped upon Chinese leaders by US leadership over recent months is well known though US jaw-boning has had very limited real effect on the yuan. Their European counterparts gave it a go last week with ECB President Trichet leading the charge saying that the yuan’s appreciation “is not exactly what we would have hoped” for, expressing his disappointment with the extent of the yuan’s appreciation since China ended its two-year peg to the dollar in June. Various other European Union and European Commission added their own version of Trichet’s comments as the week wore on. In response, China’s central bank head Zhou Xiaohuan defended his country’s decision to only allow the yuan to strengthen gradually, saying an alternative “shock therapy” approach would be dangerous. It appears that officials are set to continue to exchange comments in the media as fears of an all-out currency war begin to grow. Officials are quick to blame China for the recent tensions surrounding the currency market since it is the largest and most effective administration pursuing interventionist policies. Not to mention China’s huge export sector, which has fueled much of the stellar growth seen in China over the last three decades, and Chinese officials protect by keeping the yuan artificially under-valued making their exports more competitive causing problems for countries trying to export their way out of recession.

Despite this all looking rather bleak from wherever you are sitting progress is being made, albeit in especially small increments. The WSJ reported last week that the yuan may soon be traded electronically by banks in the US and Europe. Currently ICAP and Thomson Reuters allow trade of the yuan on their electronic platforms, which supports trade with Chinese and foreign banks located in Hong Kong. The platform however, could be expanded beyond the city’s limits in what would mark another step toward the currency being traded in the global market. The report said that talks are ongoing with US and European banks about using the new system, until recently Hong Kong banks have been trading the yuan between themselves using over-the-counter (OTC) transactions or brokers. Electronic dealing would provide open pricing and volume data, key to enhancing the transparency, and would connect a larger pool of market participants.

Elsewhere, data released Friday showed that China had reversed its purchases of Japanese bonds in August silencing analysts who had suggested in recent weeks and months that China’s flight to safety, in the form of Japanese bonds, had led to the recent bout of yen strength. The Japanese yen trades close to its 15-year highs against the US dollar and Japanese officials had publicly expressed concern that China’s government bond purchases were adding unwelcome pressure to the yen, however, the officials seem to have been mistaken. The data showed that China sold 2.018 trillion yen worth of Japanese assets in August, selling back most of the 583 billion yen it bought in July and the 2.3 trillion yen it had accumulated in the first half of the year. Our understanding of this reversal was reflective of a different reversal taking place in China’s diversification plans. The shift by China to yen bonds came amid the fiscal crisis in Europe. Now that the crisis looks to be over, these assets are ‘meant’ to be euro denominated and have now returned to be so. The flight from euro denominated assets seen across the market, in which China partook, is now in the process of being unwound. Chinese Premier Wen Jiabao last week even showed support for purchasing Greek debt when the country reintroduces open sales. Wen said that he believed Greece had weathered the worst of the financial crisis and was beginning to emerge on a path to brighter days. Therefore, it appears that the flight to safety that has led to the recent yen strength cannot be blamed on China’s actions leaving Japanese officials somewhat perturbed.

Looking at the week ahead, China is due to release its trade figures for September on Tuesday which should be closely watched by many of China’s trading partners. A second downside surprise in the trade surplus could serve to lift some of the pressure off Beijing to allow its currency to appreciate. Meanwhile, at the end of the week the Communist Party of China’s meeting to discuss the nation’s next Five-Year Plan gets underway. While the Five-Year Plan doesn’t carry the same weight it did before China moved to a market-orientated economy it’s still the nation’s key policy blueprint and players will be on the look out for any information leaked as the debate begins. Final details won’t be released until the National People’s Congress meets next March, the plan will cover 2011 through to 2015.

Written by Jonathan Granby, DailyFX Research Team

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