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Sunday 08, January 2017 by

USD/CNY and The Deal

The January 20th inauguration day for President-elect Trump looms large for CNY along with his statement that he will label China an FX manipulator and invoke trade tariffs (note too Trump will hold a press briefing on Jan 11).

Indeed, CNH has just staged its biggest one-day rally on record (+2.27 per cent vs. USD), while onshore CNY gained 79bps, only matched once on August 12, 2011. How much of this is just short position unwinding amid a liquidity squeeze? How much is aimed at giving into the threat of tariffs?

Rewind the tape and you will find that there were tentative signs that China was attempting to counter Trump’s threat of trade tariffs by allowing a more visible CNY appreciation against a basket of currencies.

The newly revised PBoC CFETS basket has appreciated by 1.6 per cent from its November 8th low just prior to the Trump’s election victory. Moreover, this maybe design, not just luck, as the daily PBoC fixings for USD/CNY have been lower than would otherwise be implied by the previous day’s global FX moves and a stable CFETS basket, i.e. since mid-November, the PBoC has been fixing CNY stronger, allowing for a trade-weighted appreciation of the CFETS basket post-Trump’s election victory. It may be naïve to think China is trying to placate President-Elect Trump’s threats against CNY weakness, or that such a subtle adjustment to CFETs will suffice. Nonetheless, this price action deserves scrutiny and may also be justified by China’s own short-term self-interest. As we have pointed out, China’s December FX reserves are expected to fall by $25 billion. Given the steady decline in FX reserves, China is stepping up measures to slow capital flight and tightening CNY and CNH funding to squeeze short RMB positions.

Part of this squeeze is seasonal and temporary, related to Chinese New Year cash demand and concern over whether last year’s January suspected PBoC intervention in 12M forwards, will be rolled over or allowed to mature and drain liquidity. However, there is the added threat of January 20th threat that China will be accused of FX manipulation unless it appreciates the CNY.  

Ultimately, we believe it is still possible for China to have a weaker CNY against USD amid broad USD strength in global FX markets, albeit not as weak as some of its key trade partners such as KRW. This means the better CNY hedging strategy over the longer-run is to be short CNH against USD, rather than the CFET basket. The move in CNH spot has brought the 12M outright back to 7.15 and 1.3 per cent below our year-end forecast for 7.25. As such, we see this position squeeze as an opportunity to add short CNH positions, but would prefer to wait until after Chinese New Year when the seasonal component of this liquid squeeze abates.

By Bank of America Marrill Lynch

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