China’s Central Bank Saves The Day, Beats Back The Yuan Haters
As expected, China’s central bank came in today to stop the bloodletting in the markets following Monday’s shocking after-market announcement by the Treasury Department that the Bank was manipulating the dollar-yuan exchange rate.
Animal spirits went into near-giddyness in the market after hours Monday, thinking Treasury would deliver a blow to China assets this morning.
China ended up doing better than expected, thanks in part to the actions of the central bank, led by Yi Gang.
The People’s Bank of China announced on Tuesday that it would provide some stability in the coming weeks to the yuan. They’ll take about 30 billion yuan ($4.2 billion) out of the market in Hong Kong on Aug. 14, they said. The move is designed to make the yuan “scarce”, giving it a chance to strengthen against the dollar. Which it did on Tuesday morning, irking last night’s short sellers.
The yuan went from 7.05 at yesterday’s close to 7.02 early this morning. It would not be surprising to see it fall back below 7 this month on the central bank’s currency moves, though for how long is anybody’s guess. The market is mostly short yuan, with economists like Bill Adams from PNC Financial Services in Pittsburgh forecasting a 7.10 exchange rate before the end of the year.
China’s major stock indexes all closed lower, but nothing out of the ordinary. Shanghai was down 1.55%, Shenzhen was down by around 1.4% and the ChiNext was down 1.56%. The Hang Seng fell just 0.67%.
Peter Navarro, arguably the biggest China hawk in Trump’s cabinet, said yesterday’s major correction in the stock market was a massive overshoot of the trade variable.
Navarro’s interview with Lou Dobb’s on FOX Business was probably not a market mover this morning, but it at least gave a chill pill to those investors who were interested in taking one.
He said he had two pieces of “good news” on China, which actually were not all that impressive.
“Finally, on Capitol Hill, there’s something that they can agree on: bipartisan support for the China tariffs and China policy. The American public has come to understand what the stakes are (and what) China is doing to us, in terms of ripping us off. We’re in a good place now. We have the market China wants access to. They’re not going to get that access unless they clean up their structural act.”
China insisted again today that it was not manipulating its currency.
Many emerging market central banks are involved in dumping dollars into the market, or soaking up their own currency in order to keep it within certain, desirable parameters. Brazil and Mexico are notorious for this.
However, despite Brazil and Mexico’s central banks’ maneuvers in the forex market, both currencies are much more susceptible to market forces than China’s yuan.
Come On, Lucky Seven!
For months, short-sellers have been aiming for a yuan exchange rate of seven to the dollar. That was resistance to breaking through to an even weaker yuan. The Chinese currency hasn’t been this weak in at least 10 years.
Seven is not some magic number, says Andy Rothman, a China bull and investment strategist for Matthews Asia.
“The latest currency move was…a short-term political signal by Xi Jinping,” he says of China’s president.
Over the last week, the U.S Dollar Index fell 0.4%, while the yuan also declined 0.6% against the dollar. Over the longer term, the direction of the yuan and dollar continues to be determined by the strength of the dollar. Since the start of the year, the dollar index is up 1.6% and the yuan is down 0.9% against the dollar. Since the start of 2015, one of the biggest blood baths in the yuan in recent years, the dollar index rose 8.2% and the yuan responded by falling 11.6%, Rothman says, hoping the past is an indicator of the future here.
“We expect this longer-term pattern to continue,” he says, doubting any significant devaluation designed to make up for higher tariffs.
Following Trump’s announcement of more tariffs and yesterday’s currency manipulator status bestowed on the yuan, investors now see little chance of a trade war resolution.
Some economists this as a multi-year trade war, punctuated perhaps by periodic incremental cease fires and mini-deals.
Meanwhile, the global economic outlook is looking more negative. Last week’s global PMI manufacturing index for July fell to its lowest level since 2012 and world trade growth has slumped.
Commodity exporter Brazil released its July trade figures last Thursday which showed exports down 11% annualized and imports down 5%. Brazilian exports, most of it going to China, have now fallen in five of the last seven months.
In an environment of increasing market volatility, investors are finding safe havens in the U.S. Treasury market, making the dollar stronger, commodities and emerging market currencies weaker as foreign investors sell their currency to buy dollar bonds. A strong dollar is no good for Trump’s trade balance with China, still breaking records.
Concerns about global growth are now reflected in a decline in oil prices and gold. The gold price is up 14% this year. Holdings in gold-backed ETF funds are at a six-year high.
Mark August 2019 as the month investors have come to the realization that the U.S. and China have reached a fork in the road.
For Beijing, 25% tariffs may just become the acceptable cost of doing business with the U.S. Many companies are still buying and manufacturing widgets in China for pennies on the dollar anyway, and cannot find that kind of scale and labor anywhere else. Neither can the Chinese manufacturers who, until now, have only been moving lower skilled manufacturing into southeast Asia, namely old school stitch and sew manufacturing.
Markets are trying to get a sober handle on the China variable and the Fed’s rate plans. After spending Trump’s first two years working at cross purposes with the White House —raising rates as Trump and the Republicans cut taxes, rolled back costly regulations, and started a trade war — the Fed is now cutting rates.
The discounting process of an escalating trade war and Fed uncertainty seems to be accelerating. It could reach a crescendo quickly, as investors saw yesterday in the knee-jerk reaction to new tariffs, tariffs that nearly every emerging markets securities investor and trader had to have seen coming.
Investors shouldn’t be surprised by two things: China’s central bank giving short sellers a run for their money. And big investors buying up U.S. equities, potentially erasing yesterday’s 600+ point loss in the Dow in the days ahead.