How Low Will The Yuan Go? Deutsche Bank Answers

Tyler Durden's picture




 

On Friday, the PBoC said it would seek to keep the yuan’s exchange rate “basically stable” at reasonable and equilibrium levels and work to further promote RMB internationalization.

As we noted earlier today, the more China moves to “liberalize” exchange rates and financial markets, the worse things will be for global risk assets. After all, when something that has been perpetually manipulated is suddenly subjected to a semi-honest price discovery process, the “adjustment” is usually violent. China is a case in point.

Indeed, turmoil in the Far East has been blamed for what has been the worst week “in recent history” (to quote RBS) for stocks and credit.

So what are the implications of more “liberalization” from Chinese authorities? What can we expect now that Beijing seems determined to not only participate in, but in fact win the global currency wars? What does it mean for the yuan to be kept “basically stable” in the context of China’s new trade-weighted RMB index?

Deutsche Bank has endeavored to answer some of those burning questions.

First, the yuan will need to “adjust” to the tune of 15% in the event the dollar rallies 5% against global currencies if the trade-weighted RMB is to remain stable. Note that it would need to fall a whopping 45% against the dollar in the event USD surges 15% against world currencies. Also note that this just assumes the RMB is kept stable (i.e. it doesn't account for a proactive move to weaken the currency further which is precisely what we've seen this week):

Put simply, the more global currencies weaken against the USD, so will the yuan. The easiest point of reference is the new CNY trade- weighted index published by the authorities last year. Taking the hypothetical case of a uniform drop of 5% in all world currencies against the dollar, this implies USD/CNY has to rise by around 15% to keep the yuan stable at current levels (chart 1). This of course implies that the currency is indeed kept stable rather than actively weakened, with the markets likely to closely watch whether we breach the key 100 level in coming weeks (chart 2).

 

Intuitively, if China moves to avoid trade-weighted RMB appreciation in the face of broad USD strength, the trade-weighted dollar will rise even more.

Put simply, if China allows USD/CNY to appreciate in line with dollar strength against other currencies, the broad trade-weighted dollar will appreciate by even more. Taking the September 2014 – April 2015 euro weakening period as a template, the broad dollar would have appreciated by 3% more had the Chinese authorities moved USD/CNY higher to offset weakness in EUR/CNY.

And that of course means the Fed will need to think carefully about further rate hikes if the FOMC wants to avoid crushing US corporate competitiveness in world markets: 

A stronger dollar, all else constant, means a slower Fed hiking cycle.

Now that China is all-in on the global currency wars, it will no longer serve as kind of pressure valve for global disinflationary pressure which means - you guessed it - more competitive easing from the likes of Mario Draghi and Haruhiko Kuroda in a desperate attempt to boost inflation:

Holding everything else constant, a higher USD/RMB (even if it just involves a stable trade- weighted currency) has negative growth and inflation repercussions for the rest of the world because currency moves are a zero-sum game. China has served as a major importer of global disinflationary pressure over the last few years and this is unlikely to continue. We note the market is therefore rightly pricing renewed odds of easing from both the ECB (and likely the BoJ), though it is important to highlight that even if this materializes it will likely be less effective than before: China will push back against competitive currency devaluations. Absent a major round of domestic Chinese easing (similar to the Japanese or European QE programs), the bigger the scale of intended depreciation on the RMB the more negative the impact on the rest of the world will be.

What's the takeaway, you ask? Well, the same as it's been since the August 11 deval. Namely, the market is struggling to understand whether China has a plan. That is, will the PBoC finally relinquish control and let the yuan find its way to a level that relieves the built-up pressure and thus stops capital outflows? Or will Beijing continue to pursue a devaluation on its own terms, thus setting the stage for more capital flight and a widening spread between the onshore and offshore spots? Nobody knows - and that is the real problem.

Bringing it all together, there are two potential long-term equilibria to China’s new currency policy: the exchange rate will either have to reach a new market- determined level that allows capital outflows to stop, or a series of restrictions on capital that prevent outflows from materializing in full force have to be put in place. From this perspective, the recent extreme widening between the onshore and offshore yuan rates (the CNY-CNH basis) give mixed signals. On the one hand it signals increased tolerance for currency weakness led by market forces. On the other hand, it is also indicative of the rising impact of capital controls (or “macroprudential” measures) because the greater the restrictions between the two markets, the smaller the ability to arbitrage the two rates and generate convergence.

 

Until the market acquires greater confidence on the intended scale of currency depreciation as well as the equilibrium level of capital outflows (and effectiveness of capital controls) concerns around China’s currency policy are unlikely to subside any time soon.

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Fri, 01/08/2016 - 13:10 | 7017851 LawsofPhysics
LawsofPhysics's picture

The PBoC will always want to be able to DEVALUE...

yeah, go ahead, give them the reserve currency, I triple dog dare you.

Fri, 01/08/2016 - 13:14 | 7017863 tarabel
tarabel's picture

 

 

Triple dog dare us?

Perhaps tomorrow. We have already eaten today.

Fri, 01/08/2016 - 13:49 | 7017991 OldPhart
OldPhart's picture

Yeah, but it was this big shit-sandwich and I've still got a lot of it caught up under the dentures.

Fri, 01/08/2016 - 14:21 | 7017901 KnuckleDragger-X
KnuckleDragger-X's picture

I really want to see that since it it would cause a massive head explosion outbreak in all the big trading houses.......

Fri, 01/08/2016 - 20:09 | 7019799 sevensixtwo
sevensixtwo's picture

When PBOC says "basically stable" they mean devaluation will continue to accelerate.

Fri, 01/08/2016 - 13:10 | 7017852 BlueStreet
BlueStreet's picture

As low as they want it to go. 

Fri, 01/08/2016 - 13:15 | 7017870 Dr. Engali
Dr. Engali's picture

All fiat eventually finds its intrinsic value of zero.   

Fri, 01/08/2016 - 13:25 | 7017904 KnuckleDragger-X
KnuckleDragger-X's picture

Value is such a magical word. I just wish people actually knew what it meant........

Fri, 01/08/2016 - 18:42 | 7019434 Gambit
Gambit's picture

Price is what you way... value is what u get, which is all realtive.  If you value something more so than the person next to you, you will raise the price and etc...

Fri, 01/08/2016 - 13:16 | 7017877 madbraz
madbraz's picture

when i see post after post in zerohedge with reference to what a TBTF shyster bank says will happen, it leads me to believe that zero is part of the MSM.  perhaps we all are.

Fri, 01/08/2016 - 13:19 | 7017887 Dr. Engali
Dr. Engali's picture

Click, click, click. That's the bottom line.

Fri, 01/08/2016 - 13:28 | 7017911 madbraz
madbraz's picture

this "click" economy is dumbifying all of us.

Fri, 01/08/2016 - 13:51 | 7017894 RaceToTheBottom
RaceToTheBottom's picture

Historically the ultimate value is always zero.

That is not debatable.

The only variable is time...  When they will reach there?

Fri, 01/08/2016 - 13:38 | 7017953 insanelysane
Fri, 01/08/2016 - 16:27 | 7018864 Niall Of The Ni...
Niall Of The Nine Hostages's picture

Many of these disappearances are pre-emptive. Rest assured Mr. Zhou is safely in Vancouver.

Fri, 01/08/2016 - 13:38 | 7017954 More Ammo
More Ammo's picture

sum ting wong

Fri, 01/08/2016 - 16:43 | 7018942 The Dogs of Moar
The Dogs of Moar's picture

you're back

Fri, 01/08/2016 - 13:46 | 7017985 My Days Are Get...
My Days Are Getting Fewer's picture

How low will Deutsche Bank go?  Juan answers:

Below zero, where DB is now on a mark to market basis.

Fri, 01/08/2016 - 14:04 | 7018059 Consuelo
Consuelo's picture

 

 

"So what are the implications of more “liberalization” from Chinese authorities? What can we expect now that Beijing seems determined to not only participate in, but in fact win the global currency wars? What does it mean for the yuan to be kept “basically stable” in the context of China’s new trade-weighted RMB index?"

 

To me - ultimately at some point, it means Gold.  


Fri, 01/08/2016 - 14:13 | 7018100 Kagemusho
Kagemusho's picture

This currency devaluation  'limbo dance' China is doing  is going to result in another 'beggar-thy-neighbor' scenario as the 'Asian Tigers' race each other to also devaluate, causing their own fragile finances to crumble. Social unrest always follows.

My Viet Namese ex- landlord, who would visit his former country every year,  once bitterly told me that China doesn't give a damn what happens to the rest of the area so long as she 'gets hers'.  If that sentiment is a popular one on the Asian Rim, then China is making lots of enemies with this.

Fri, 01/08/2016 - 14:58 | 7018352 Consuelo
Consuelo's picture

 

 

That's a well known, but seldom mentioned-in-polite-company trait...    My old lady says it is largely due to the effects of Communism - wherein everyone had to be for themselves amongst grinding poverty and shortage, lest they perish.   I tend to believe her since grew up in the area.

Fri, 01/08/2016 - 16:42 | 7018935 The Dogs of Moar
The Dogs of Moar's picture

so

China doesn't give a damn what happens to the rest of the area so long as she 'gets hers'

Would those be the same neighbors  --  the rest of the area  --  who are falling in lock step behind the US and inviting the US to lead them in challenging Xi about China's claims for the South China Sea?

Fri, 01/08/2016 - 17:46 | 7019217 RMolineaux
RMolineaux's picture

Several cautions on evaluating this item:

Not mentioned is the old fail-safe:  "other things being equal."  

The item mentions a Chinese entry into the currency war and a desire to "win."  There is nothing in Chinese action to date to justify these unnecessarily hostile characterizations.  On the contrary, its desire to maintain the excange rate in accordance with a trade-weighted basket of currencies is fair and laudable.  It has already expended enormous amounts of exchange reserves to attain this goal.  One can only hope that it will continue this program and ignore any pressure to leave the matter in the hands of the "market."

The  wild card in the process is the problem of capital flight.  Wealthy Chinese, both domestic and overseas, along with their non-Chinese confederates have developed a destructive mindset.  This is the idea of maintaining the dollar peg, and the perception that any weakening of the yuan against the dollar is a sign of future Chnese weakness overall, and sufficient reason to convert yuan to dollars at every opportunity.

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