China strikes back

Marius Paun | London, UK | Senior dealer | Wednesday, 07th August 2019

Last week US President Donald Trump announced 10% tariffs on the remaining $300 billion of Chinese imports. The move came after the Federal Reserve was less dovish than Trump’s liking (judging by his tweets).

In reaction, China’s Yuan weakened to a record low against the US dollar, as more than seven yuan are needed now to buy one greenback. As a consequence, the US Treasury was quick to label China a ‘currency manipulator, devaluing the yuan while maintaining foreign exchange reserves, despite using such tools in the past’. Now, it is acknowledged that China’s currency does not float freely but is managed as a matter of policy. By and large it only fluctuates within a predefined channel.

Nonetheless there is a widespread opinion that China has in fact kept the yuan strong, in the past, for two main reasons. Firstly, if China wants to keep growing by exporting to the world (Belt and Road Initiative is testimony to that) they will want to make yuan part of global currency reserves club (up there with the US dollars, euros, yens, pounds and so on). One cannot do that with a shaky currency.

Secondly, China is, and has been, worried for a while about capital flights. At any sign of currency trouble, investors (foreign or domestic) could decide to take their cash out of China. So defending the yuan is a way to discourage capital outflows.

But in order to do that China needs to sell US dollars. Ok, it has a trillion dollars in reserves, but why squandering these reserves to prop up your own currency, in the middle of a trade dispute. Especially when the other side desperately wants a weaker currency themselves. Does that mean the trade dispute might take longer than initially expected? We shall see.
Interesting to note is that a devalued Chinese yuan could export deflation all over the world. And that’s the last thing the West needs amid low growth, low interest rates and ongoing weak inflation.

From the technical analysis point of view, the chart shows the overall trend in USDCNH is bullish.

We saw a sharp rise above psychologically important 7.0 mark recently. That level proved good resistance in December 2016 as well as October last year. It managed to break above the sideways range of 6.68 – 7.0 where it has been fluctuating since March 2018. So the uptrend remains intact.

The price now sits comfortably above the 9 week (red) and 21 week (green)moving averages so a retracement to resistance turned support of 7.0 could be considered. We note that the 9 week moving averages has crossed above the 21 week moving averages in May this year which, in hindsight, proved good buying signal for USDCNH pair. Interestingly these moving average crosses were effective signals, both in January 2019, when they gave an indication of a bearish move, and end of May 2018, a bullish trend (blue circles).

There are a string of lower supports, which proved good levels, at 6.90, 6.85, 6.79 and 6.68 shown by the red stripes. We note that support around 6.68 mark also represents 50% Fibonacci retracement from a high of 7.13 to a low of 6.24 (February 2018) alongside 6.79 as a 61.8% Fibonacci retracement.