China report: stabilization short-lived? - TDS

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Jan 13, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    FXStreet (Guatemala) - Analysts at TD Securities explained that things continue to settle down in China, with CNY spot fix at 6.5630 today, an insignificant 2 pips above yesterday’s.

    Key Quotes:

    "But over the last five days, the onshore renminbi has fixed in a narrow 6.560/6.565 range as the CNY-CNH spread was falling to close to zero on sharp offshore convergence to the onshore rate.

    The USD/CNH collapse from the past few days has closed the gap entirely, as onshore and offshore renminbi are now trading at around 6.5750. Indeed the move has been favoured by the dramatic spike in CNH implied yields from the past days that the China authorities have supported, to make shorting the CNH virtually impossible. TN and overnight rates have now fallen back to around 10%. These are still elevated levels although they pale in comparison with TN rates in excess of 100% only two days ago, while 1m, 3m and 12m implied yields remain relatively high at around 8.5%, 7.5% and 5%, respectively.

    So while things are normalizing, also aided by the better than expected trade numbers today (both exports and imports stronger than expected), there’s still a lot of uncertainty about measures that the China authorities may take to limit the re-widening of the onshore-offshore spread.

    This is especially true when considering that the recent RMB inclusion in the SDR basket doesn’t allow for dual currency valuation, so eventually there should be only one reference value for the RMB.

    Therefore, any arbitrage opportunity between CNY and CNH will be fought against. In this context, the loud and clear message is that the CNH-CNY spread has to remain low and the China authorities will pursue this goal through a wide range of measures, including some more extravagant ones that have led to squeezing CNH liquidity and boosting short-term implied rates. Indeed, it took more than FX market action in order to engineer the surge in HIBOR, and some degree of coordination between China and Hong Kong’s monetary policy makers via Hong Kong’s banking system in order to ensure liquidity tightened enough to make CNH-shorts too costly to hold, without cutting CNH liquidity off completely.

    This is not a rabbit that China is going to want to pull out of the hat often, given the costs that it imposes on the offshore economy (in Hong Kong or otherwise) that utilizes CNH for real economic transactions rather than purely speculative ones. However, Chinese policy makers have in the short term likely achieved their goal of instilling a degree of fear in markets such that speculative shorts will become much more tentative in driving a large gap between the CNY and CNH rates.

    However, the trade data today also suggests that portfolio outflows continue. In fact trade numbers were relatively strong, but China burned record amount of reserves in December. These two facts are inconsistent with one another unless we decide that the bleeding comes from the financial account, or is related to direct interventions. Probably a combination of the two, with capital outflows still dominating. If this is really the case, CNY will remain tilted to more weakness going forward, and any stability in USDCNY or USDCNY fixing will rely on more FX reserves burn.

    Given all that is on their plate, markets remain understandably skittish about long EM and risk positions. But as long as data from China feels under control, whatever the underlying causes or ultimate goals are, a small pick-up in risk sentiment can materialise. Yesterday, sentiment improved throughout the Asia session and European morning hours, but when North America kicked in, risk appetite started to fade. So far today, we see that resurgence of positive sentiment, but remain concerned that as Europe fades out, a more negative view may take over.

    In broad terms, we remain relatively positive on EMs for 2016."
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