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Chinese Yuan Remains Stable Despite of BOJ Decision

Chinese Yuan Remains Stable Despite of BOJ Decision

Renee Mu, Currency Analyst

Fundamental Forecast for the Yuan: Neutral

The yuan offshore rate (CNH) moved little against the dollar early this week, as China’s central bank held the reference rate steady and guided the daily rates in a tight range between 6.5516 and 6.5557. Bank of Japan’s unexpected decision to move rates to negative territory added volatility across the currency market. The Chinese yuan closed with a bullish position on Friday following the BOJ's decision. As China has just made multiple announcements to warn against Yuan Short speculation, we expect in the coming week that the reference rate will remain tight, and both the onshore (USD/CNY) and offshore (USD/CNH) yuan rates will remain rather firm. Chinese January PMI and Caxin PMI figures to be released next week will be the key event drivers to the Yuan.

Japan, one of China’s most important trade partners, surprisingly announced negative interest rates on Friday. The CNH/JPY surged to 18.3130 from 17.9327 following the decision. The timing of this cut is tough for China. While it may release some tension in Chinese stocks– the Shanghai Composite Index gained 3.09% on Friday after it dropped for three consecutive days; this can be troubling news for China. A cheaper Yen, or say a more expensive Yuan, means that Chinese products become more expensive on a relative basis. This will put additional pressure on China’s already weak exports. Of specific focus, major equipment products that China sells to Japan are highly labor intensive such as electronic equipment, machines and clothing. The price elasticity of those products is high; meaning the demand on those products can be reduced significantly due to higher prices. The Chinese government will not need to devalue the currency; a weakened export condition will eventually drive the yuan lower, in the long run.

In terms of the short-term impact of BOJ’s rate cuts to financial markets, this will drive capitals flows out of Japan to other markets, including China. Thus, we may see some improvements in Chinese stocks due to this move to negative rates, but the benefit is limited as China’s capital market is not yet fully opened.

Also, as we have discussed in previous weeks, the performance of Chinese equity markets constrains the Yuan’s floating range - no two fires in the same house at the same time. So normally, when a crisis in the stock market is seen as being managed, regulators’ controls on the Chinese yuan should be relaxed as well. However, in the past week, Chinese state media and officials sent out messages that “China has no intention to devalue the currency or start a trade war”, it is less likely that they switch the tone immediately in the coming week even if the equity market is improved or after its neighboring trade partner adopts an aggressive stimulus policy. Thus, the Chinese Yuan is likely to stay relatively stable in the next weekly session.

In addition to the above themes, China’s January PMI figures to be released in next week are worth keeping an eye on as well. Remember, the December Caixin PMI ratio was the trigger to the most recent plunges in Chinese stocks. As of today, the Shanghai Composite has dropped by -22.6% in a month, the largest monthly drop in over 8 years. Of course, the PMI reading itself was not the sole contributor to that move, but it has likely become a major driver of sentiment. In a market with 80% of transactions made by retail investors, many rely more on news and rumors than on solid information and analysis, and as the old saying goes - once bitten, twice shy.

Overall, the Chinese yuan in the next week should remain relatively stable. However, the hidden pressure from BOJ rate cuts may be released over a longer period of time.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.