Currency Point – Currency Point The Peg

FX has been rocked by the ramp-up in action of the US-China trade war.

The fact the PBoC is now willing to use the RMB as a mechanism to counter-tariffs is a new dimension for markets. It also shows that the FX market has now become a ‘battle ground’ and thus risk and commodity currencies will be impacted as the battle ramps up. i.e. AUD, NZD, CAD and EUR.

Thus, we need to quantify how big a move this was from the PBoC, what USDCNY could look like going forward and what this means for floating FX more broadly.

So how big was it?

Evaluating the initial fix (last Monday) above 7 clearly caught the market off guard. It was one the hardest devaluations from the PBoC since the fix was brought in back in 1994. It also signaled that Beijing is now ready to go toe-to-toe with Washington on trade issues.

It’s the preceding fixings that should really catch your attention, here is why:

• Tuesday saw a 450pip depreciation in USDCNY – it was taken as a ‘positive’ as it was more ‘conservative’ than expected. However, that 450bps drop was the 8th largest single day move since 1994, which to me signals this is structural. Now, if we couple the initial fix devaluation and then the next 3 day only 4 other times since 1994 has the PBoC gone harder. August 2015 which saw an 8% decline in CNY (6.1 to 6.8). July 2018 which lead to a 10% depreciation of 2 months, June 2016 where CNY was weakened by 8% (6.5 to 6.95) the final time was January 2017 when the fix was controlled by the China Foreign Exchange Trade System without countermeasures.

Conclusion from the moves last week – China is about to undertake a structural devaluation of the RMB.

So how could this proceed?

• The action by the PBoC is clearly in response to the new tariffs coming on September 1. Thus if we look back over the past 18 months since the US-China war begun China has done this before which begun in June-July last year. Over a 4-month period the PBoC move the RMB down 10% in a slow and steady, almost stealth like policy shift seeing RM hitting 6.9 from 6.3 in April. Interestingly it didn’t affect market stability but was fast enough not to invite speculation. One should expect this again

So where could USDCNY end up?

• Using history again as a uide and the ranges we have seen in the past of 8% to 10% depreciation levels it easy to make a case for the pair to be in a range of between 7.4 to 7.5 come December. Now that is speculative and this idea would change if the trade war for example was to dissipate. But it’s a reasonable assessment judging on previous moves.

Finally positioning for USDCNY movement

• First and foremost, have 11.15am (AEST) on alarm, this is when the PBoC fixes the RMB, then position from there in either a risk off or risk on set up depending on the fix.
• Second is watch the Washington response – “Currency War”, “manipulation”, “unfair” etc. etc. from the President and his other hard-line China hawks will likely push the USD around a bit but by and large it’s pretty empty. The bigger risk is if there is USD side intervention. Now this is unlikely and hard work considering the size of the USD market. But, this President is unconventional so it not outside the realms of possibilities. This is a risk so get your stops out.
• Asian focused FX are the pairs in play, thus to position for moves in RMB use AUD, NZD on the short side. JPY on the long.

Final point – volatility is here thus evaluate your risk as gapping and whip events are very likely.