China’s cur­rency has omi­nous 7 in sight as bear­ish bets mount

Gulf Times Business - - BUSINESS -

Bets are mount­ing that China’s cur­rency will slide to a level not seen since the global fi­nan­cial cri­sis, as the govern­ment tries to shield the econ­omy from a trade war.

The no­tional value of new op­tions bet­ting the yuan will weaken past the psy­cho­log­i­cal mile­stone of 7 per dollar is at the high­est since de­pre­ci­a­tion pres­sure re­ally be­gan to pick up in June. Last week saw more wa­gers added than in mid-Au­gust, when the cur­rency hit a 19-month low and au­thor­i­ties used ver­bal warn­ings and stronger fix­ings to de­ter spec­u­la­tors. Bears are also act­ing in the for­wards mar­ket, where the off­shore yuan’s 12-month out­right con­tracts slid past 7 for the first time in over a year.

The cur­rency, one of Asia’s worst per­form­ers this year, is un­der re­newed pres­sure as China re­acts to the trade war threat and the coun­try’s mon­e­tary pol­icy di­verges from the US, where in­ter­est rates are on the rise. China’s cen­tral bank said on Sun­day it would cut the re­serve re­quire­ment ra­tio, which typ­i­cally weak­ens the ex­change rate. When trad­ing re­sumed fol­low­ing a week-long hol­i­day, the yuan slid 0.8%. It rose 0.1% to 6.9196 on Wed­nes­day in Shang­hai.

Bank of Amer­ica Mer­rill Lynch and JP­Mor­gan Chase & Co are among the global banks to have low­ered their yuan fore­casts, pre­dict­ing it will hit 7 ver­sus the green­back within six months. That’s a level it hasn’t reached in more than a decade, be­cause the govern­ment – wary of cap­i­tal out­flows – hasn’t al­lowed it to.

When the yuan edged towards 7 in Au­gust, the Peo­ple’s Bank of China ar­rested the de­cline by mak­ing it more ex­pen­sive to bet against the cur­rency, while also set­ting the daily ref­er­ence rate stronger than fore­cast for an ex­tended pe­riod. In early 2017, when the ex­change rate was about 0.5% from that level, the govern­ment engi­neered a dra­matic liq­uid­ity squeeze to burn bears.

“China may find yuan hit­ting 7 more ac­cept­able now, be­cause it’s pri­ori­tis­ing looser liq­uid­ity over a strong ex­change rate and it’s less con­cerned with fund out­flows thanks to cap­i­tal con­trols,” said Tommy Xie, an econ­o­mist at OverseaChi­nese Bank­ing Corp in Sin­ga­pore. “How­ever, a break of the level will likely trig­ger faster drops in the yuan and hurt stocks, so we could see more in­tense of­fi­cial man­age­ment at that point.”

New yuan put op­tions, which pro­vide the right to sell the cur­rency, with a strike price of 7 or weaker to­talled $12.5bn in the five days end­ing Oc­to­ber 5, com­pared with $4.9bn the pre­vi­ous week, ac­cord­ing to Bloomberg cal­cu­la­tions based on data from De­pos­i­tory Trust & Clear­ing Corp. Op­tions prices show the chances of the yuan hit­ting 7 by the end of March jumped nearly 10 times since mid-June to 42%.

The off­shore yuan’s 12-month for­wards, re­flect­ing traders’ bets on the cur­rency in the com­ing year, tum­bled as low as 7.0582 per dollar on Mon­day - the weak­est since May 2017. The on­shore yuan’s one-year non-de­liv­er­able for­wards also fell be­yond 7 this week.

The PBoC still has tools to ar­rest the yuan’s slide, from out­right dollar sales to squeez­ing off­shore liq­uid­ity. In­deed, there are al­ready signs of tight­en­ing: one-month in­ter­bank bor­row­ing costs in Hong Kong spiked on Tues­day to the high­est since June 2017.

“I re­main cau­tiously bear­ish on the yuan, but I think the path to 7 will be a bumpy one,” said Stephen Innes, Sin­ga­pore-based head of Asia Pa­cific trad­ing at Oanda Corp. The PBoC has “a mas­sive war chest to right the ship.”

Here are some of the fac­tors ag­gra­vat­ing the yuan’s weak­ness:

The PBoC has low­ered the RRR for a fourth time this year

The yield spread be­tween China and US 10-year govern­ment bonds is near the nar­row­est since April 2011, mak­ing yuan as­sets less ap­peal­ing

China’s for­eign-ex­change re­serves shrank the most since Fe­bru­ary last month. The drop was big­ger than ev­ery fore­cast in a Bloomberg sur­vey of econ­o­mists

Re­la­tions be­tween the US and China ap­peared to de­te­ri­o­rate dur­ing Sec­re­tary of State Michael Pom­peo’s re­cent visit to Bei­jing. He said there was “fun­da­men­tal dis­agree­ment” with China’s for­eign min­is­ter

Chi­nese stocks tum­bled the most since June on Mon­day. For­eign in­vestors sold $1.4bn of main­land-listed shares through ex­change links with Hong Kong

Over­seas in­vestors last month in­creased hold­ings of Chi­nese bonds at the slow­est pace since March

China has a po­ten­tial headache right ahead, as Wash­ing­ton weighs whether to name the coun­try a cur­rency ma­nip­u­la­tor in a re­port next week. That would prob­a­bly be a sur­prise, but a se­nior US Trea­sury of­fi­cial said Mon­day the Trump ad­min­is­tra­tion is con­cerned about the yuan’s weak­ness.

An em­ployee ar­ranges yuan ban­knotes at the Korea Ex­change Bank head­quar­ters in Seoul (file). The yuan is un­der re­newed pres­sure as China re­acts to the trade war threat and the coun­try’s mon­e­tary pol­icy di­verges from the US, where in­ter­est rates are on the rise.

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