As the People’s Bank of China (PBoC) have detailed, there is little basis for persistent yuan depreciation. There is certainly some merit in this, but much hinges on the outlook for the USD.
We can see US assets continue to become more attractive on a relative basis, so if we look at the yield premium commanded by the China ten-year treasury over the US ten-year treasury, we can see this coming in from 142 basis points (bp) in July to currently stand at 92 bp - the lowest premium since March. On a relative basis, this is boosting the attractiveness of the USD to Chinese investors and we believe the Q3 balance of payment data (when released on 4 November) will show a reasonable pick-up in outbound portfolio and direct investment, assisted by further external lending. This should be partially offset by foreign inflows into China and RMB deposits, which can be a reflection of the RMB’s recent inclusion in the IMF’s SDR (Special Drawing Rights) basket.
Importantly, the CNH and CNY has been stable against the PBoC’s currency basket (known as the CFETS or China Foreign Exchange Trade System), throwing weight behind the idea that the USD has been the pre-eminent driver of USD/CNY of late (as opposed to pure CNY weakness).
When forecasting the USD, one should not by overly concerned about the Federal Reserve (Fed) hiking rates in the December meeting, but by the potential pace of hikes in 2017 and 2108. Recall, the Fed detailed in September that they might raise rates twice in 2017, however the interest rate market is far more sanguine with an 80% probability of just one hike currently priced in. This seems fair given a number of longer-term macro-economic uncertainties that need to play out. However, If US core inflation starts to tick higher from here, with wage growth at the centre of this, then the USD will attract strong capital inflows. This is certainly a big ‘if’ and our belief is that we should see US inflation pressures contained in 2017, with real GDP averaging around 2-2.2%. Certainly not an environment where the Fed should raise aggressively, which should keep the USD from rallying too greatly over the longer-term.
Chinese investors likely to buy gold and bitcoin
If we see USD/CNH moving progressively higher without any major breakout in range expansion, I would expect Chinese investors to look very intently at buying gold and bitcoin. Bitcoin especially has a strong correlation with USD/CNH, so this could be an interesting asset to put on the radar.