The Chinese yuan (CNY) will be included in the International Monetary Fund's (IMF) Special Drawing Rights (SDR) basket
The CNY will have a weighting of 10.92% from October 2016
The EUR is sacrificing a 6.5 percentage point share within the basket. If there is a belief that we could see demand for CNY as reserve managers re-weight portfolios to take into account the CNYs inclusion, then in the same vein we could see selling of EURs.
Importantly, the prospect of a rush of capital flooding into China to purchase CNY assets seems very low.
The obvious benefit of the CNY’s inclusion in the basket is that it provides China some scope to accelerate financial reform and continues the push for liberalisation. Of course, the key is opening up the capital account and making the CNY fully convertible, however this is some time away and will be a gradual process. There is also a view that it could give the People's Bank of China (PBoC) more freedom to manage the exchange rate and therefore promote the idea we could see a longer-term CNY devaluation.
The belief within Chinese ranks that future CNY inflows would cause currency strength would be troublesome for the Chinese authorities who are struggling with disinflationary pressures. The CNY on a trade-weighted basis is at multi-year highs and China have been progressively losing competitiveness relative to their Asian export peers for some time. In fact, if you think about exports in terms of volumes, Europe would be the big concern. As EUR/CNY falls to the April (and all-time low), China faces reduced purchasing power from European importers, but at the same time an increase in Europe’s overall competitiveness. Goods and services have to come from somewhere and as EUR/CNY falls, pressure will be seen in China’s exports as global importers favour Europe instead. The CNY needs to undergo a longer-term devaluation.
My personal belief is USD/CNY is going to increase from here and retail traders can express this view with yuan traded offshore - CNH. Being long USD/CNH is a strong consensus trade for 2016 and there is no doubt that the Chinese trading public feel the USD is likely to rally further from here. That makes specific US assets very attractive and one questions if this means US housing is about see an influx of Chinese buyers. I suspect we will.
The SDR is effectively a basket of ‘reserve’ currencies. A country whose currency has ‘reserve’ status often enjoys significant benefits when it comes to trade, as their counterparty will already have the currency in their portfolio. Although the role of the SDR has diminished over the years, global central banks still hold 3% (or $280 billion) of their entire FX reserve in SDRs. the USD currently commands a 41.9% weighting, EUR is 37.4%, GBP is 11.3% and JPY makes up 9.4% of the SDR basket.
- By Chris Weston, IG's Chief Market Strategist
IG provides an execution-only service. The material above does not contain (and should not be construed as containing) personal financial or investment advice or other recommendations, or an offer of, or solicitation for, a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of the above information. Consequently any person acting on it does so entirely at his or her own risk. The information does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result.
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