Morning Commentary: Bouncing Back

Foreign Exchange - Morning Commentary

Bouncing Back

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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The Chinese yuan has rallied this morning on the back of support from the Chinese government.  Overnight, the PBoC announced that it would issue new yuan bills in Hong Kong, a move that is aimed to tighten liquidity and showcase the central bank’s willingness to defend the currency. 
Additionally, the yuan’s fix came in slightly lower than models would have predicted, implying the possibility of a slight bias from the Chinese government for a stronger currency.  Coinciding with these steps are reports that the US will grant a handful of temporary 90-day exemptions to its ban on US sales to Chinese telecom giant Huawei.  These steps mirror the actions the US took against ZTE last year.  Ultimately, Trump overturned the ZTE ban in exchange for Chinese concessions and price action appears to reflect the markets expectations for a similar path for Huawei.
While these steps have eased tensions for now, and is driving a rally in European and US stocks around the world, the trade conversation still remains very fluid and risks still remain for further escalation especially in light of the nationalistic shift in Chinese rhetoric. This then begs the question of what the market impact would be should the US impose a 25% tariff on all Chinese exports. 
The most obvious first order impact would simply be the cost of the tariffs on goods as a 25% tariff would make things more expensive, although this is likely offset somewhat by the expected depreciation of the yuan.  The more concerning impact would come through what is known as second order impacts—the deterioration of business confidence and tighter financial conditions.  In models from the IMF, it has been estimated that these second order effects can be two to three times larger than first order impacts. 
However, these second order impacts are notoriously hard to quantify, especially in China’s case as it is a command economy.  Case in point, the Chinese banking sector doubled in 2009 in the aftermath of the global financial crisis as credit around the world tightened.  Nevertheless, these second order effects merit monitoring as the negotiations between the US and China continue to evolve.     
  • GBP has moved sharply higher on expectations that PM May will present a new Brexit proposal in a speech today.  Her new proposal is expected to touch on workers’ rights, environmental protections and assurances on the integrity of the UK in the event that the backstop kicks in.    
  • In yesterday’s commentary, we highlighted skepticism on the AUD’s move higher based on election results and pointed to Governor Lowe’s scheduled speech as a possible driver of AUD weakness.  The AUD finds itself lower today after Lowe’s dovish speech, and RBA minutes have reaffirmed the possibility for rate cuts.  Currently, markets are showing a ~95% chance of a cut this year. 
  • Thailand reported soft GDP growth with Q1 growth coming in at 2.8%, the slowest pace since 2014. 
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