China Warns It Is Ready To Slow Yuan Plunge On Capital Outflow Fears

Tyler Durden's picture

It was just one year ago when the biggest worry for the market - which culminated with a near 10% S&P correction in in early 2016 - was the daily plunge in the Yuan driven by the surging dollar, which in turn prompted China to engage in an unprecedented reserve liquidation (in which it sold both government bonds and equities), leading to a daily selloff in risky assets on days when the Yuan was fixed lower.

Fast forward a year later, when the US Dollar has blown through last year's highs and is now at levels not seen since 2003, the Yuan is trading at record lows, just shy of 7.00, and yet stocks stubbornly ignore the one catalyst that led to so much headache for the bulls one year ago.

In his daily note, RBC's cross-asset strategist Charlie McElligott points out that while the market may be oblivious, what is taking place in China is something to be concerned about:

ONE IMPORTANT TACTICAL MACRO POINT WITH REGARDS TO THE NEAR-TERM DIRECTION OF USTs / GLOBAL LONG-END: The yuan ‘slow bleed’ devaluation by the PBoC versus the USD seen since the start of October has without question been tied to at least some of the weakness in the US long-end, as the central bank sells USTs to try and mitigate the depreciation of the yuan against the SDR basket—see here:

 

One notable distinction from last year is that while bond yields would slide on days when the PBOC intervened to stabilize the currency by selling TSYs, this time around the selling of both assets is taking place concurrently - as shown in the chart above -  which may suggest that China's capital outflow pressure is far greater than what the PBOC would be willing to admit.

It may also explain why the market has been oblivious to the collapse in the Yuan:so far China has kept a very low profile when it comes to its market response to the aggressive devaluation of its currency. But that may be about to change.

As Reuters writes overnight, "Chinese policymakers have been unfazed by the yuan's recent slide, but are ready to slow its descent for fear of fanning capital flight if the currency falls too quickly through the psychologically important 7-per-dollar level, policy advisers said."

The inertness of China's central bank stems from the fact that "Chinese policymakers believe the decline in the yuan since October reflects market trends, especially of late when most currencies have fallen in the face of a resurgent U.S. dollar."

A policy advisor said that "the central bank is following the trend as the dollar is rising. It's not necessary for it to resist market forces."

Not necessary for now.

Ironically, just as Trump has been a blessing in disguise for Europe and Japan, both of whose currencies have plunged against the dollar in the past week on expectations of Trumpflation, so China has also benefited from the weaker currency: "appropriate yuan depreciation will be good for stabilizing market expectations and the economy, as long as there is no sharp, run-away depreciation."

All of that is about to change however, if the dollar continues its relentless push higher, in the process tripping the 7.00 stops in the Yuan:

Beijing's biggest concern is that a sharp fall in the yuan will trigger the sort of capital flight that followed August's surprise devaluation of the currency, which sparked fears the health of the economy was worse than Beijing had let on. China's currency reserves slumped by more than $400 billion by the end of January as Chinese moved cash overseas.

 

Outflows from the $3 trillion-plus reserves, by far the world's largest, have since continued at a much more subdued pace but the yuan's decline in recent weeks has raised some concerns that capital flight could pick up again if the yuan slides too fast.

Asked about when the Yuan may cross the psychological barrier, a PBOC advisor told Reuters that "I don't think the breaking of 7 is imminent. We may have to wait until next year." Actually, at this rate, "breaking" of 7 may happen as soon as next week, to which he adds :"If the pace of depreciation is too fast, if it hit 7 before the end of this year, the central bank will control it."

And that's when the liquidation of Chinese USD-denominated reserves begins in earnest, among all those other measures the PBOC implemented a year ago when the market was far less sanguine about the Chinese devaluation:

The policy insiders said the central bank was likely to intervene in currency markets and enforce capital controls to slow the rate of decline in the yuan.

As we expected, the intervention has already started:

traders said large Chinese state banks had offered dollars in the domestic currency market on Thursday in an apparent effort to slow down the depreciation of the yuan. They said there had been no sign of state dollar selling in previous sessions.

Another way of saying "offering dollars" is selling US assets.

And then there are other threats, like how China will respond to the foreign policy programs soon to be adopted by the president-elect who had made trade with China, and the imposition of tariffs, one of the biggest policy points in his presidential campaign.

Concerns about a sharp slowdown in China's economy have eased to be replaced by worries that Beijing could be heading into a trade war with the United States if Trump follows through on his campaign rhetoric. Trump lambasted China throughout the election, drumming up headlines with pledges to slap 45 percent tariffs on imported Chinese goods and to label the country a currency manipulator.

 

China was regularly criticized by the United States and some other western governments who argued it used a cheap currency to boost exports. But that criticism has died down in recent years as economic growth slowed and as the government sought to shift away from a reliance on exports and more towards consumption.

 

"Imposing tariffs on China would do more harm than good for the United States, including its employment, and it has to consider that China could counter with its own measures," said a commerce ministry researcher.

For now China, like the market, is hoping that Trump won't rock the boat...

"I don't think the exchange rate will become an imminent problem. The yuan is depreciating but won't depreciate too much and many people believe the dollar could fall if Trump takes some radical measures."

 

Chinese President Xi Jinping told Trump that cooperation was the only choice for relations between the world's two largest economies, with Trump saying the two had established a "clear sense of mutual respect".

 

Assuming no major ructions from a Trump presidency, some government economists expect the yuan to fall to 7.2 per dollar by the end of 2017, which would imply a drop of 4.2 percent from the current level.

... which, however, may prove to be idealistic. Ultimately, the question will be at what point do China's residents and savers start pulling out their funds and transferring them offshore - as they did last year   - to avoid further loss in purchasing power. 7.00 on the Yuan sounds as good a point to "call it" as any, which means. Which incidentally is dangerously close from the latest print in the USDCNH, now trading just above 6.90.

Another week at the current pace of devaluation, or just a 1-2% increase in the DXY, should do it.

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Pinto Currency's picture

The Yuan plunges as Treasuries are sold due to a declining economy:
http://www.safehaven.com/article/43077/president-trumps-immediate-emergency
Unless China can stop its declining trade surplus and economic slowdown, the Yuan decline will continue.

KnuckleDragger-X's picture

China has come to think of themselves as the tail that wags the dog. Too bad Trump is unlikely to go along with them......

bada boom's picture

So they are admitting they are currency manipulators?

But then again, aren't all currencies manipulated.

Bill of Rights's picture

Like one gigantic pressure cooker, and someone forgot to screw in one side of the lid.

Jason T's picture

it's a matter of Trust.

..the closer to the fire the more you get burned.  

so stay away from commies. 

Jus7tme's picture

If PBoC uses USD reserves to buy CNY, are they not in fact aiding and abetting the process of people escaping from China with USD?

Seasmoke's picture

And yet still no one ever mentions Gold ...,,

johnjkiii's picture

What to do when markets anticipate something that might happen as soon as something else takes place? Go the opposite way. Wait for the cash market to slow and short the dollar. This is nothing but safety pins and crying rooms for forex traders. Reminds me of Y2K, swine flu and Clinton's lock on the presidency.

Ecclesia Militans's picture

Chinese will invest in US infrastructure, giving their capital a place to flow but returns the impetus to come back to the motherland.  Trump gets trillion dollar stimulus without having to dip into Treasury, and China gets future cash flows from tolls on the Garden State Parkway.  Win-win.

OliverAnd's picture

Why in the world would the Chinese invest in American infrastructure?  Inorder to stabilize the Chinese currency requires them to first flood the market with USD increasing supply simultaneously decreasing demand and thus value.  Selling USD and buying Juan will decrease supply simultaneously increasing demand and thus value.  US infrastructure and expansion/ultramodernization of the military will be funded by the FED by printing USD.  Trump's companies will make record profts from infrastructure and Republicans will keep quiet as they make money through military contracts waiting to see which is the new nation they will eventually invade.

gdpetti's picture

That's a boatload of wishful thinking.. the Chinese aren't idiots... they may buy assets that are moveable, and even those that facilitate their exports into the USA etc... but they need to unload all that Dollar based debt as soon as they can unless they want to get stuck with it when the music stops... and this situation allows them the opportunity to do so quiet like... under the radar, as those watching those radar screens have no intention of drawing attention to this simple fact.... THe Chinese are thinking long term... helping the US imperial fall as graciously as possible unless we cause too much trouble.... the Chinese want time to switch their countries markets and take our place.

I think one problem here is that we hear alot about those Chinese seeking to get their ill gotten cash out of the country before getting caught.. they aren't the govt nor its industries. THe Chinese govt has its own One Road project to spend their profits on...

Omega_Man's picture

dump the shit dollar and buy gold 

flaunt's picture

"Another way of saying "offering dollars" is selling US assets."

How does that follow?  They sell US treasuries and then use the USD to buy something else?  Strictly speaking selling USD-denominated assets is the equivalent of bidding for dollars not offering them.