Me Still Love You Yuan Time

China recently raised the Reserve Requirement Ratio by 50 bps to 16.5%
for its domestic banks.  This is the second hike in the past month and
certainly not the last as China’s economy is still sprinting ahead. 
While equity markets have begun to price in the risk of “global exit
strategies,” currency markets have yet to consider the implications of
continued strong underlying growth in China.  It is likely that
additional Chinese monetary tightening will be accompanied by pressure
to revalue the yuan.

We came across an interesting piece from
Ned Davis Research recently that increases our conviction for a Chinese
currency revaluation.  Recall we first discussed the prospects for a
major revaluation of the renminbi here. 
NDR compiled the table below to illustrate current economic indicators
relative to levels seen in July 2005 and July 2008 – other instances
when China changed their currency peg.

Source:
Ned Davis Research, Inc.

For individual investors unable to
trade currency forward contracts, the Wisdom Tree Dreyfus Chinese Yuan
Fund (CYB) remains the best vehicle to position for this event.  CYB is
comprised primarily of U.S. government, corporate and treasury bonds;
repurchase agreements; and short-term currency forwards.  The fund seeks
to achieve total returns reflective of both money market rates in China
and changes in value of the Chinese yuan relative to the USD.  While
CYB does make income distributions, investors should not expect large
movements in value until an actual revaluation takes place, so patience
is a virtue.  That being said, when viewed relative to earning
approximately nothing in a US savings account – and the near certainty
of decaying purchasing power due to reckless monetary and fiscal policy –
we are happy to sit and wait.  As we stated in our initial post:

We don’t believe
that today’s expectations accurately reflect the yuan’s true
trajectory.  To effectively dampen China’s underlying inflationary
pressures, exchange rates would have to rise substantially more than
levels implied by the market today.  A 50-100% revaluation is even
plausible if trends in commodity prices persist, and as history
suggests, China overshoots in policy accommodations.

Disclosure:  At the time of
publication, the author was long WisdomTree China Yuan Fund, although
positions may change at any time.

Comments

[Anonymous]

I view the USA and China as a giant partnership with the USA consuming/borrowing/protecting while China producing/lending/managing(slave labor). With the yuan tied to the dollar, the other Asian tigers must support the dollar in Treasury auctions to maintain competitiveness. With the eurozone the only floating currency they get screwed as evidenced by the ongoing PIIGS/UK debt crisis which only worsen. The USA is the only country that has infinite power to print/borrow money, the world's largest military and gold holdings. The number 1 and soon to be number 2 economies in the world has and will continue to control the world's economic picture. The yuan will not appreciate relative to the dollar unless the partnership ends.

[Maynard-Kenyes]

I have read many articles about the up and coming yuan appreciation, but I do not agree with those assumptions. aus_punter, you pointed out one of the things I have been telling many people. The USD rising against the euro, as well as the yen gives China the ability to consume more goods cheaply from those nations.  China will not raise the value of the yuan. China keeps the yuan unchanged in value, they can then use the ASEAN free trade area to their advantage as long as the other Asian nations currencies appreciate versus the USD. We will see many currency and market moves that continue to defy all sense of market normalcy. 

[aus_punter]

If you think the Chinese have any desire to revalue the Yuan upwards given the almost 12% depreciation of EUR/USD you are seriously deluded

[Squid-puppets a...]

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