Morning Commentary: Another One Bites the Dust

Foreign Exchange - Morning Commentary
Another One Bites the Dust
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Earlier in the week, the People’s Bank of China (PBoC) allowed USDCNY to trade above the closely watched 7 to 1 level for the first time in a decade.  By allowing the yuan to trade above 7 to 1, the PBoC has made its daily fixing a closely watched event.  To this end, the PBoC broke another milestone overnight by setting its daily fixing rate above 7 for the first time since 2008.  The daily fixing rate is the midpoint of the band for which the PBoC will allow the CNY to trade. 
While the fixing was the weakest fixing in over a decade, market reaction has been fairly calm.  Ultimately, the fix was stronger than expected, and the markets took this move as a sign that Chinese authorities are attempting to establish stability in the markets. 
The question now becomes, what does the future hold?  Although Chinese authorities have stated it doesn’t expect the yuan to continue to weaken significantly, allowing the currency to break a closely watched level does make further depreciation easier.  This potentially raises FX intervention on the US side as another potential issue in the US-China showdown. 
In the end, we still see US intervention as a last resort event.  The White House is unlikely to start intervening unless it is confident that it can sustainably weaken the dollar.  To this end, theory and real world evidence suggest that successful intervention would require 1) no Fed sterilization or 2) coordination with other central banks like with the Plaza Accord.
The issue the US is facing is that neither of these conditions are present.  Unsterilized intervention isn’t possible without violating the Fed’s congressionally-protected independence, and other countries will not coordinate with the US as they don’t see an issue with the USD’s current level.  Moreover, unilateral intervention would undermine the USD’s reserve currency status which would increase the risk premium or compensation that investors would demand to hold US assets.               
  • The CNY was also helped by Chinese trade data that showed both imports and exports beating expectations.
  • EURUSD is up sharply on the session after drifting lower in the overnight session.  The catalyst for the spike up was news reports that Germany could make a U-turn on fiscal policy and issue new debt. 
  • After dropping to a seven-month low yesterday, oil is trading higher on the session after comments from Saudi Arabia that it would consider all options to support oil prices. 
  • Despite the increase in tensions, US-China talks scheduled for September are still expected to go through. 
  • The spread between Italian and German 10-year bonds hit its widest level in a month as, once again, Italy’s coalition government looks close to collapse. 
  • Japanese portfolio data showed Japanese investors to be net buyers of foreign bonds with US Treasury demand near the highs for the year. 
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