Brief FX & Rates: Chinese Renminbi – Canary in the Coal Mine and more

In this briefing:

  1. Chinese Renminbi – Canary in the Coal Mine
  2. Conservative FX Markets Testing (Some) Extremes

1. Chinese Renminbi – Canary in the Coal Mine

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While the United States and China have not gone as far as re-introducing or increasing tariffs on each others’ imports, the war of words between the two trading superpowers has clearly escalated with Hong Kong caught in the middle.

In line with our expectations the Chinese Renminbi has depreciated versus (a weaker) Dollar and in nominal effective exchange rate terms in recent weeks (see Figures 1 & 2).

Precedent suggests the Renminbi’s slide to an 11-week low is not coincidental but the by-product of the PBoC’s conscious decision to modestly weaken its currency and send a clear, if subtle message to the United States that China can retaliate in more ways than one.

The implications of a breakdown in US-China relations and a resumption of a full-blown trade war would of course reach far beyond a possible acceleration in the pace of Renminbi depreciation.

For starters any sustained Renminbi weakness would likely increase the odds of other Asian currencies also depreciating versus the Dollar with hands-on central banks keen to maintain their countries’ export competitiveness, particularly at this current juncture.

It is no coincidence, in our view, that Asian currencies on the whole remain highly correlated with the Renminbi and have underperformed since 12th May (see Figures 3 & 4).

Moreover, the introduction of new import tariffs would, based on precedent, likely have a material and negative impact on world trade at a time when macro data suggest that global economic activity has only just started to very slowly recover from a very low base.

Any further headwind to global trade would likely delay any meaningful recovery in global supply and demand (see Figure 5) and cast further doubts on whether sequential global GDP growth can forge a V-shaped recovery in Q3 and Q4 2020 – the topic of our next Smartkarma Insight.

2. Conservative FX Markets Testing (Some) Extremes

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The majority of major developed and Emerging Market currencies have contnued to trade in narrow ranges versus the US Dollar in the past three weeks. 

The five narrowest ranges (<1.5%) have all been recorded by Asian currencies. We attribute this to the willingness and ability of Asian central banks to keep their currencies broadly aligned with the currencies of their main trading partners – namely the Chinese Renminbi and US Dollar – which have been particularly stable in recent weeks.

27 of these 32 major currencies have depreciated or appreciated by 2.5% or less against the US Dollar over this period.

On the surface it would seem that markets, faced with acute uncertainty, are keen to fade any material currency moves.

However, half of these 32 major currencies were, as of yesterday’s close of business, at or testing the extremes of their admittedly (in most cases) narrow ranges versus the US Dollar, with the Brazilian Real within touching distance of its record low (hit on 8th May) and conversely the Philippines Peso at a multi-year high.  

The question is which of these currencies is likely to extend their gains/or losses and/or potentially break out of its recent ranges.

Near-term we see downside risks to the Chinese Renminbi and Brazilian Real versus the US Dollar and Swiss Franc.

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