Unpegging the CNY

The ‘fix’, done every day at 11.15am AEST, is where the People’s Bank of China (PBoC) treasury department, known as the ‘State Department of Foreign Exchange’ (SDFE), choose an intraday mid-point price and then uses its foreign reserves in a supply and demand fashion to ‘fix’ the currency around that point during the open season.

Source: Bloomberg

This has now shifted somewhat. The shift in China's currency stance is interesting from two fronts:

1) The PBoC is now shifting to a pseudo-floating exchange rate and that is reflective of China wanting to export its deflation problem.

2) The impact on foreign exporters is only beginning. The devaluation seen in the last three days has caused USD denoted products to increase in value by 3.5% and so the CNY has further to fall.

What does this mean for the rest of the markets?

The moves in USD/CNY is the first sign that the PBoC is going to use the market as a mechanism to devalue economy. This is actually consistent with China’s stated future outlook on fiscal policy. The deregulation of its close-market system is something they are looking to rectify over the coming years. They have also stated that they want a ‘freer-floating’ currency in the coming decade as they look to liberalise its finance market. The shift here is that the SDFE is now allowing the currency to ‘freely-trade’. The ‘fix’ is now reacting to the spot trading price from the day before by matching the mid-point on the following day – pseudo-free floating.

This is a big move from the norm: it underscores that China is concerned about the state of the economy and the fact that most analysts see the yuan as 10% over-valued. The new ‘floating mechanism’ around the fix will let the currency move in the direction that the market believes the yuan should. However, what they are effectively doing is exporting deflation - this is a concern from the perspective of foreign exporting.

I would also caveat; this is not China entering the coined ‘currency wars’. The current FX shift from China is the equivalent of bringing a spoon to a knife fight; if China was to enter the ‘currency war’, it would blow currencies out of the market with an array of monetary leavers all at once. The PBoC has no interest in doing this as it would create volatility in the yuan it doesn’t want, nor is part of its mandate (though that doesn’t mean it won’t be in the future). China doesn’t do halves, this is an eight at best.     

The effect on exporters however is currently unquantifiable, and that creates uncertainty which triggers risk off trading (ie the trading in the ASX). The reaction in industrial metals in the past two days illustrates the pressure exporters will feel in the coming months. Commodities, which are priced in USD, will now appear even more expensive to a market that is already seeing sluggish demand. The importation of ores to gold, goods to services into China just got harder and the fact the CNY may decline a further 10% from this point just adds to the woe. It will filter out over time as clarity around the new FX strategy merger over time. However, when more questions are being raised than answered, the risk of selling will always increase.

Ahead of the open

Interestingly, in the final 15 or so minutes of US trade, the SDFE brought up the yuan and it still saw devaluation in the yuan intraday but reduced the daily sell-off. This means the ‘fixing’ today will be a little less savage than the past two days.

Commodities stabilised and the US markets recouped the loss from the open. Interestingly, the US bounce was the protection of the 200-day moving average – if this breaks, the down-side will be interesting.

Something to also be aware of – the horrible events overnight where a ship carrying explosives erupted in the port of Tianjin is likely to impact commodity prices. It will cause a short term bottlenecking, iron ore shipments into China are likely to be disrupted, and it could have a short term effect on pricing.    

After entering a technical correction yesterday, I would expect the ASX to calm down slightly today and may even see green on screens. We are calling the ASX down six points to 5375, with all eyes once more on 11.15am.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

Find articles by analysts

Een artikel zoeken

Form has failed to submit. Please contact IG directly.

  • Ik wens per e-mail informatie van IG Group bedrijven te ontvangen over handelsideeën en IG's producten en diensten.

Voor meer informatie over hoe wij uw gegevens mogelijk kunnen gebruiken, bekijkt u ons Privacy- en toegangsbeleid en onze privacy website.

CFD’s zijn complexe instrumenten en brengen vanwege het hefboomeffect een hoog risico mee van snel oplopende verliezen. 79% van de retailbeleggers lijdt verlies op de handel in CFD’s met deze aanbieder.
Het is belangrijk dat u goed begrijpt hoe CFD's werken en dat u nagaat of u zich het hoge risico op verlies kunt permitteren.
CFD’s zijn complexe instrumenten en brengen vanwege het hefboomeffect een hoog risico mee van snel oplopende verliezen.