Marius Paun | London, UK | Senior dealer | Friday, 08th January 2021
The Chinese yuan is at its strongest against the US dollar since June 2018. At the start of 2020 the rate of USDCNH was trading around the 7 levels, but recently it went to 6.5. Times changed, mid-2019 the world was worried that China might let its currency weaken drastically, rattling markets and sparking disinflation across the globe. And that’s because the yuan was devalued on purpose (went the saying) so the state could export that deflation. And that was the last thing the West needed amid low growth, low-interest rates and ongoing weak inflation. Now the tables have turned, the yuan is strong and worries of devaluation are gone. What has changed?
For quite some time there was this speculation that the rate of USDCNH of 7 is a threshold, a line in the sand closely watched by investors and Chinese authorities alike. China has been trying for years to increase its domestic demand which could help it diversify and possibly convince investors it is not just a big exporter. After all, there is a widespread opinion that China, being the major supplier of goods in the world, was a significant disinflationary factor for the world (along with demographics).
The Chinese government had to walk a fine line. When the trade war with the US hit the country, allowing yuan to devalue seemed like a solution to boost exports and in turn spur growth. Nonetheless, China had to keep the yuan strong for two main reasons. Firstly, if China wants to keep growing its exports, and the Belt and Road Initiative is a case in point, it will also want to make yuan part of global currency reserves elite. It would be impossible to do that with a second-class currency.
On top of that, at a time when just about any central bank in the world is trying desperately to spark inflation, devaluation would be hardly welcome. But in fact, the USDCNH at the 7 thresholds was crossed in September 2019 when the rate touched 7.2. Strangely enough who came to the rescue? You guessed it, Covid-19. The pandemic went global in early 2020 but by May last year, China started to recover while the rest of the world was still struggling with high numbers of infections. As a result, the yuan got increasingly stronger. And if China is indeed keen to have a go at the US dollar status as the world’s main reserve currency, it can not do that with a weak yuan or being perceived as overly interventionist.
What else has pushed the yuan higher? First, the interest rates over there are much higher than the US or Europe. That will attract capital which should drive up the Chinese currency. On the other hand, it’s a two-way street, it’s also about the US dollar getting weaker. And that is good news for risky assets in general as markets are awash with liquidity.
However, if a weak yuan is a potential deflationary risk for the rest of the world, the opposite is also true. A strong yuan could push up the price of Chines exports. In addition, China would buy more commodities, which in turn could boost demand for raw materials even further. And that might happen as the world is trying to recover from Covid-19 pandemic and go back to ‘normal’. So a strong yuan means potentially higher inflation.
Why is that a threat, especially when central banks are almost begging for it? Coming at a time when the dollar is getting weaker, oil is recovering, the world is hopeful the vaccines would do the trick in the end even is infections are on the rise now. We may get too much inflation rather soon? Watch this space. When the genie is out of the bottle….. and inflation has the reputation of hardly ever coming in small enough doses.
After a double top just below 7.2, the USDCNH started its rather steep decline in May last year. The price is now below the short-term and long-term moving averages and both are pointing down. Currently, the market price is near the 23.6% Fibonacci retracement from a high of 7.1963 touched on 01/09/2019 to 6.2357, the low of 25/03/2018. The first line of support is around 6.4115, Tuesdays’ low.
On the upside, 6.52-6.535 range will be the first hurdle for the buyers followed by the 38.2% Fibonacci retracement around 6.6. If they manage to overturn the short-term trend, serious resistance can be seen at 6.6860 which acted as good support in the first few months of 2019.