Yuan Depegging Essay

Market voice Yuan de-pegging: what it means for Asia Callum Henderson, global head of FX strategy and Thomas Harr, senior FX strategist at Standard Chartered in Singapore, predict the effects of China’s yuan de-pegging on currencies in Asia and around the globe On Monday, June 21, China de-pegged the USD/CNY exchange rate, resuming the process of making the exchange rate more flexible, which halted in July 2008 when USD/CNY was re-pegged in response to the global credit crisis. Immediately after the de-pegging, USD/CNY showed significant volatility. On June 21, it was fixed at 6. 275 – unchanged from the previous Friday – but thereafter was allowed to trade substantially lower. On June 22, it was fixed at 6. 7980, but then ramped sharply higher. The message from the Chinese authorities is clear – the focus is currency flexibility, not necessarily appreciation. Both fundamentals and realpolitik support a continued appreciation, but much will depend on short-term moves in other important exchange rates such as EUR/USD and USD/JPY, and the US dollar more generally. If the first week of greater flexibility was anything to go by, it could be a bumpy ride.

We expect USD/CNY to reach 6. 70 by year-end and 6. 56 by July 2011. A more flexible yuan will have limited immediate impact on Asian economies, especially given our expectation for a slow and moderate appreciation against the dollar. A stronger yuan is expected to create renewed upward pressure on other Asian currencies, especially the Taiwan dollar, Singapore dollar and Malaysian ringgit. China’s import concentration in raw materials and high-tech capital goods and a stronger yuan should boost China’s demand for such products.

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For commodities, the expectation of robust demand from China could help support prices. The change could also affect Asia indirectly: if the market is again pricing in the yuan to appreciate moderately in the long run, capital could return to Asia in search for yield – which could imply that Asian central banks’ worries over asset inflation could return soon. Fundamentally, the global recovery remains on track, led by Asia: and, while central banks elsewhere will probably keep interest rates low for an extended period, Asia ex Japan (AXJ) central banks will tighten monetary policy.

This should trigger renewed capital inflows, boosting AXJ currencies. During May, offshore investors massively reduced long AXJ positions and they have only recently A stronger yuan is expected to create renewed upward pressure on other Asian currencies dipped back into AXJ risk. Hence, we judge the market is only modestly short USD/AXJ. The Standard Chartered Risk Appetite Indicator turned back into risk-neutral on June 17, having been in risk-aversion since May 26. This is a clear positive signal for risk appetite.

On balance, the de-pegging of the yuan should be bullish for AXJ currencies even if China moves very slowly during the first months. Based on correlations with the yuan, positioning and recent performance, we believe that the Singapore and Taiwanese dollars, the Malaysian ringgit, Korean won and Indian rupee stand to benefit the most from yuan de-pegging. Malaysia competes directly with China in export markets, and Bank Negara Malaysia operates a managed float against a trade-weighted currency basket of which the yuan is a significant part.

The Singapore dollar will benefit from the fact the yuan carries a weight of around 11. 80% in the SGD NEER basket. The Taiwanese dollar should also benefit substantially from yuan appreciation. While Taiwan does not officially target the exchange rate in terms of monetary policy, the Taiwan central bank often makes reference to the TWD NEER and China accounts for around 26% of Taiwan’s trade. The won should also benefit, as China accounts for more than 20% of Korea’s trade: also, the won is very liquid and is often used as a proxy for general AXJ risk.

The yuan de-pegging might add to short-term US dollar negatives. The biggest G-10 beneficiary of yuan de-pegging has been the yen, reflecting trade and investment links between China and Japan. However, the correlation between USD/CNY non-deliverable forwards and USD/JPY has been negative since September 2009, in line with the often negative correlation between USD/AXJ and USD/JPY. Hence, while the yen might benefit initially, the positive impact might not last – and could indeed be reversed. The Australian dollar hould also benefit from yuan appreciation due to the deep integration of the Australian and Chinese economies. Other commodity currencies such as the Canadian dollar should also benefit, and the euro and British pound should benefit modestly. Gradually, as market expectations for large yuan appreciations in the next few weeks are disappointed, we are likely to get some retracement of these moves, particularly as the market refocuses on euro area fundamental problems. FX 22 FX Week July122010 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.


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