China's Leading Index has fallen to its lowest since Feb 2009 this evening, down 4 straight months from credit-driven 18 month highs. This economic weakness has exaggerated the already weak tone in Yuan trading this evening pushing CNY to its weakest in almost 7 months (against the USD), its furthest on record from the CNY Fix (10-month highs), and very close to the PBOC's upper +2% band for CNY trading. At 6.23, USDCNY is over 1000 pips weaker than the CNY fix. We suspect the weakness in Yuan is also driven by further corruption crackdowns as China will require VIP gamblers in Macau to undergo a record check.
China Leading Index hits lowest since Feb 2009...
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By way of interest, The China Leading Index includes:
Hang Seng Mainland Freefloat Index, industrial sales, M2 money supply, new fixed asset investment, logistics index (total freight traffic and volume of transportation in major harbors), real estate investment (land and construction of residential properties), consumer expectations index, Treasury yield spread (spread between treasury securities with maturities of 7+ years and those with less than 1 year maturity).
Putting further pressure on the Yuan as selling pushes it to the weakest against the fix on record (over 1000 pips lower)
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As a reminder, here is Goldman Sachs on the Yuan's unusual dynamics...
Unusual dynamics in the RMB
Since the beginning of November, the daily onshore USDCNY fix published by the PBOC and onshore USDCNY spot have persistently diverged. (recall that the PBOC publish a daily onshore fix at 9:15am local time and that onshore spot is allowed to trade in a range of +/-2% around the fix after the market opens at 9:30am). Divergence isn't totally unusual. There have been periods when the fix has been essentially stable for a period of time, but onshore spot has either appreciated or depreciated. However, this recent period marks the first prolonged episode that the CNY has appreciated on the onshore fix but onshore spot has weakened.
Judged on the daily fix, the CNY has appreciated by 0.4% against the USD since early November, with the recent fixes close to levels of early March. However onshore CNY spot has depreciated by 1.8% to 6.2230 against the USD, not that far from the highs of end April and beginning of June. Thus onshore spot has traded on the weak side of a modestly appreciating fix determined daily by the PBOC. This period also marks the first time that onshore spot has weakened without obvious policy encouragement - usually onshore spot depreciation is triggered by a move higher in the fix and, earlier this year, aggressive intervention.
China growth concerns likely lie behind the weakness of onshore spot
Chinese activity remains somewhat fragile. The business survey data are not particularly encouraging and industrial production and import data have surprised to the downside on recent readings. Against this backdrop, the authorities have persistently eased policy through both monetary and fiscal channels in order to ensure that the 2014 growth target is achieved. In that light, the recent weakness of onshore spot has shades of developments elsewhere – namely that weak growth and monetary easing has led to a weaker currency.
The recent weakness of the CNY vs. the USD has done very little to dent the currency’s strength on a trade-weighted basis. In the year to date, the CNY TWI has appreciated by 8%, partly as a function of the CNY’s heavy management against the USD (the USD TWI has appreciated by 8.5% this year). This is adding to concerns over Chinese activity on two fronts. A strong currency in principle should weigh on export performance. We have encountered many client arguments that the CNY should depreciate given the weakness of the Yen, Euro, KRW and TWD given the export similarity between these countries. Indeed, it is interesting that the depreciation trend in onshore in the CNY started around the time of the surprise BOJ easing move on October 31, after several months when onshore spot had appreciated against the USD. The strength of the currency on a TWI basis tightens financial conditions, which would also dampen growth, particularly in conjunction with the recent run up in Chinese rates.
The CNY is stronger on the fix
The strength of the CNY on the daily fix likely reflects China’s increasing trade surplus, which reached a new record in November. Since the May trade data was released in June, the CNY has appreciated notably – by 0.3% on average - around the monthly release of the trade data. The size of the trade surplus (even if we do not think that the trade surplus is as large as reported – see this recent EMMD) is likely to make it optically difficult to depreciate the CNY on the fix in international circles.
It is also worth noting that the authorities regularly talk about the need for a stable currency in order to encourage confidence in the RMB by global investors - so as to foster its role as an international currency - as well as of domestic corporates and households - to limit risk of significant capital outflows.
On the latter, China has recorded notable outflows given that the trade surplus remains strong, but reserve accumulation has stalled in recent months. Indeed a stable to stronger currency may be preferred to prevent greater outflows. We looked at the developments in China’s external balance in a recent FX Views and did not find the recent outflows to be fundamentally driven. On December 21, PBOC Deputy Governor Yi commented that the CNY will stay basically stable despite fluctuations and the 2% CNY move against the USD was not considered a depreciation.
Outlook for CNY from here
In the very near term, if current dynamics continue, it is possible for onshore spot to touch the weak side of the trading band for the first time since the +/-2% trading band was introduced in March. If it stays there, CNY direction would then depend on the fix and this is likely to be the key near-term signal for CNY spot.
Looking further ahead, our baseline view for 2015 is more of the same – i.e., that the fix will continue to be set in a fairly wide range with limited direction. Our end 2015 forecast for the USD/CNY fix is 6.16 and the range of the fix could remain similar to that since early June 2014, between 6.17 and 6.1150. But if further FX reform steps are taken a wider range for the CNY fix between 6.10 and 6.20 is clearly possible. A risk to our view is that the CNY fix is weaker than we anticipate in Q1 2015 and a repeat of the weakness early this year could be engineered given the likelihood of soft growth through the quarter on account of the reinforcement of anti-corruption measures around Chinese New Year and a likely seasonal drop in the trade surplus. Onshore spot would continue to trade in the weak side of its daily trading band as a result.
Aside from the direction of the CNY fix, we will also watch for more market based reform steps. It is likely that onshore spot will be allowed to trade fully within the +/-2% range, including hitting the strong and weak sides of the band. The fix could become more market determined and we will watch the PBOC commentary for any hints of another widening of the daily trading band.
This extremely strange trading behavior (as JPY also pushes to cycle lows) corresponds to the surge in mainland China stocks (and slide in Hong Kong stocks)... SHCOMP +54%, HSI unch since QE-Lite
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As the world and his mum 'smartly' try to front-run a broad-based rate-cut that China has vowed not to undertake.
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