Morning Commentary: Much Ado About Nothing…For Now

Foreign Exchange - Morning Commentary
Much Ado About Nothing…For Now
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The Chinese yuan moved below 7 this week for the first time since March.  An upside surprise to China’s June PMI numbers set the stage for bullish sentiment that was then amplified by this week’s strong equity rally.  

While the yuan only broke below 7 this week, bullish momentum has been building since the end of May.  Prior to the end of May markets were concerned over renewed US-China tensions.  However, harsh rhetoric failed to materialize into significant economic action.  This has allowed for a reduction in CNY risk premia as markets to look past concerns around rising tariffs and a failed Phase 1 trade deal and refocused on re-opening momentum.  Near term, supportive interest rate differentials and the market’s continued discounting of geopolitical risks opens up room for further yuan strength.  However, Chinese officials are unlikely to allow significant appreciation.  

Over the medium term risks still remain with the US considering sanctions and/or boycotts on a variety of issues.  Yesterday the key headline focused on the potential for the US to undermine the Hong Kong dollar peg.  My view would be to fade these headlines as such action is highly unlikely.  Instead the focus should be on the potential sanctions on Chinese banks.  Additionally, risks still remain on China falling behind on its Phase 1 deal obligations.  Being tough on China should remain a key campaign issue and this makes it likely that US-China rhetoric will worsen as we get closer to the election. 

In a nutshell, this is the predicament that the yuan finds itself in.  Economic data and the resulting growth differentials support the currency.  Yet it is important to remember that policy has a strong influence over the currency with geopolitical risks holding a dominent role in the yuan’s valuation.  That makes signals from policy makers a key guide for price action.  With US-China geopolitical risks likely to increase, yuan should remain vulnerable to depreciation. 
  • The global number of COVID-19 cases now exceeds 12 million.  Outside of the US, numbers are increasing in Hong Kong, Japan, Australia and Mexico.  In the US, California set a new record on its daily increase in new cases and Texas a second day in a row of record deaths.    
  • US initial jobless claims came in better than expected with 1.31 million claims filed against expectations for 1.38 million claims.  Last week’s number was also revised down to 1.41 million from 1.43 million.  Continuing claims also beat expectations at 18.1 million against expectations for 18.8 million.  While these numbers were better than expected, they still remain extraordinarily high and suggest that the labor market remains under pressure despite economies re-opening. 
  • Democratic presidential candidate Joe Biden will give a speech today on his economic plan.  Based off reports, Biden’s plan will stick closer to a centrist path than a progressive one.  Biden’s plan is expected to call for a boost to manufacturing and innovation with progressive ideas like the Green New Deal and Medicare for All shelved for now.  
  • UK Chancellor Sunak’s Summer Statement announced additional stimulus of GBP30 billion on top of GBP160 billion that was previously announced.  The new stimulus focuses on employment support.  Other measures including a VAT cut for tourism and tax cuts for the housing market. 
  • China’s Shanghai Composite recorded its 8th straight day of gains.  The Shanghai Composite index is up ~16.25% on the month.  
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