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Down but Not Out
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Andrew Kositkun Foreign Exchange Head Trader
Since the beginning of June, Chinese yuan (CNY) price action has been a one-way street of currency appreciation. However, over the past week, the CNY has come under pressure. While weakness in global risk assets played a role in the yuan’s recent weakness, the Oct. 27 announcement from the People’s Bank of China (PBoC) that it would suspend the counter-cyclical factor (CCF) in its daily currency fixing accelerated the yuan’s decline.
The CCF was first introduced in May 2017 as a tool to reduce FX volatility and allow the PBoC some discretion in its fixing at a time when financial outflows from China and broad U.S. dollar (USD) strength were key market concerns. The CCF was then suspended in January 2018 after a period of USD weakness and reintroduced in August 2018 when the yuan was facing intense depreciating pressure due to U.S. tariff threats.
In essence, the PBoC tends to make changes to the CCF after periods of sharp currency weakness or strength. Because of this, markets see the removal of the CCF as a sign China is aiming to prevent or limit further currency strength. Of course, the fact that China also removed the 20% reserve requirement on shorting CNY forward positions shortly before removing the CCF only solidifies the view that Chinese authorities are growing uncomfortable with currency strength. As a result of these recent moves from the PBoC, it is understandable why some market participants are hesitant to bet on further yuan appreciation. But there are still compelling reasons why the yuan can continue to strengthen.
The acceleration in COVID-19 infection numbers in Europe and the U.S. stands in contrast to a more controlled dynamic in China and most of Northern Asia. This suggests that growth numbers out of Asia should not only remain resilient but could also improve on a relative basis. This stronger growth outlook should lead to FX strength. Additionally, the FX preference of Chinese authorities is nuanced. While removing the CCF suggests a preference against yuan strength, it also means less PBoC influence in daily CNY fixes, which is consistent with Beijing’s desire to internationalize the yuan. With less government influence, the strong balance of payment dynamics and relatively high interest rates in China can more directly support the currency.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
U.S. annualized third-quarter gross domestic product (GDP) increased 33.1% against expectations for a 32.0% gain as the economy rebounded from its 31.4% annualized contraction in the second quarter. Even with the strong third-quarter numbers, GDP remains 3.5% below its pre-pandemic peak. It is important to remember that GDP numbers are backward looking. Looking forward, the economy is losing momentum, with fiscal stimulus fading and COVID-19 cases and associated restrictions rising.
U.S. initial jobless claims came in better than expected at 751K claims versus expectations for 770K claims. Continuing claims also dropped to 7.8 million from last week’s revised 8.5 million print.
The Supreme Court issued two rulings involving mail-in ballots. The high court left a six-day extension in North Carolina intact and refused to schedule a fast-track review of a GOP appeal involving Pennsylvania. Thus, far more than 76 million people, or 55% of all people that voted in 2016, have already cast their ballots. In Texas, early voting numbers show that votes totaling more than 91% of 2016’s total have been cast.
The European Central Bank (ECB) left its rates and asset purchase program unchanged. However, the bank did signal that risks were tilted to the downside and that it would recalibrate its instruments as appropriate based on the new staff projections scheduled for December. With economic risks tilted to the downside, these new macroeconomic forecasts should skew negative and put the bias for further easing at the ECB’s next meeting.
The Bank of Japan (BOJ) kept all of its policy setting unchanged as was widely expected. Like other central banks, the BOJ warned on the economic outlook and risks posed by the virus.
Next year marks the 100th anniversary of the Chinese Communist Party. The country is currently working on its strategy for the next five years, which should continue to shift away from targeting absolute growth to focusing more on qualitative measures, such as self-sufficiency and the environment. This aligns with the country’s “dual circulation” approach that rebalances away from external to internal growth engines.
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