Yuan Volatility to Continue on PBOC Activity, CPI and Equity Volatility
Fundamental Forecast for the Yuan: Neutral
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The offshore Yuan (CNH) rate closed at a five-week low against the US Dollar on Friday following the biggest downward move in Yuan fixing by the PBOC since the Yuan’s de-pegging. The onshore Yuan (CNY) touched 6.5092 on Thursday, the weakest level in a month. On a weekly basis, the onshore Yuan was down -0.36%. The Shanghai Composite Index eased early gains this week and dropped -2.82% on Friday, the biggest daily loss since March. Major commodities in China also fell this week after hitting multiple limit-ups in the previous week. Looking into next week, the Central Bank’s moves on the daily fix, as well as volatility in Chinese equity and commodity markets will continue to weigh on the exchange rate. Additionally, China will release key economic reports next week including April New Yuan loans, Consumer Price Index (CPI) and trade data.
The volatility in the Yuan’s reference rate has increased of recent and this trend is likely to continue. Before March, a 200-pip move on the fix was rare and yet over the past two weeks, we have seen this take place multiple times. The PBOC fixed the rate 238 pips stronger on April 26th and an additional 365 pips on April 29th, and then weakened the rate by 378 pips on May 4th. Such big moves may reduce market speculation on one-way moves in Yuan rates. More importantly, the Central Bank is showing control in guiding rates lowers of recent unlike previous instances that received global attention. Ahead of the Yuan’s August de-pegging as well as the January devaluation, the spread between onshore and offshore rates widened significantly, and this increased depreciation pressure on Yuan. The weakness in the daily fix was more led by external forces and the market reaction was likely more-related to panic with capital rushing out, like a sudden tire burst caused by a change of the weather. It appears as though the Chinese Central bank knows that there is excessive air in the tire and are looking to release the air gradually before the tough weather comes, such as what may occur when the Fed next hikes rates. Over the following periods, traders may see additional Yuan weakness guided by the Central Bank for such a reason.
Next week, there are major event risks coming from China, which may add volatility in Yuan rates. The April Consumer Price Index (CPI) report is one such report: Pork prices, a major contributor to CPI, remain at elevated levels despite the government introducing policies in the effort to stimulating the supply. The consensus forecast for CPI by Bloomberg is 2.3%, the same as March. Higher-than-expected CPI prints could affect the Central Bank’s monetary policy and, in turn, impact Yuan rates. April’s New Yuan loan report is another indicator worthy of watching. The all-time high new yuan loan print of 4.61 trillion in the first quarter raised concerns that the Chinese government would attempt to continue using stimulus to boost the economy as they did during the 2008 global financial crisis. The government news agency responded that the country will not resort to large stimulus measure and the rapid increase in loans was temporary. The April new Yuan loans data will be a good gauge of that statement.
Also, recent turbulence in the Chinese equity and commodity markets could impact the direction of capital flows to China. China’s equity markets have been stabilizing over the past two months, and the Shanghai Composite Index is testing major resistance at the psychological level of 3,000. However, the equity market comes into the spotlight again as major shareholders of multiple listed companies have reduced their holdings over the past few days. This raises concerns on whether such reductions will cause another round of selling in the equity market and, in turn, drive capital flows out of China. At the same time, the commodity market has cooled a bit this week with the government’s intervention. The fever in Chinese commodities has led to an increased risk of price bubbles. Next week, traders will want to keep an eye on the commodity market to see whether the upward trend is remains moderated or whether the cooling down is only a temporary observation before new highs print yet again. The latter could be harmful to the Yuan rates.
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