Just after 9:45pm ET the offshore yuan - the one which is not subject to the PBOC's trading band limits - tumbled, plunging 250 pips in minutes.
The move was unexpected, following a stronger than expected setting of the USDCNY by the PBOC, whose midpoint was set at 7.1092, far stronger than the 7.1220 expected and the 12 year low of 7.1293 hit on Tuesday. The drop comes just hours after Bloomberg reported that Trump administration was considering sanctions including transaction controls, and asset freezes, over the implementation of the new national security law in Hong Kong.
While the offshore yuan is not at all time lows yet - it would need to hit around 7.20 for that - there has been no news to justify the move, with the sudden move sparking speculation that Beijing may be using it to telegraph the devaluation that could follow should the US escalate aggressively in response to a Hong Kong crackdown.
Here, once again, is a reminder from Rabobank's Michael Every why in the current environment of escalating hostility between the US and China, the only thing that matters is the Yuan, and why in the not too distant future, the Chinese currency may have a 10-handle in front of it.
This time last year, when we were all still going abroad regularly (right now just ‘outside’ is becoming a psychological barrier if I am honest) I was traveling with a presentation titled “Clause is Cause”. This argued that from a geostrategic ‘Von Clausewitz’ perspective, not a neoliberal “Let’s assume world peace” version, the US would at some point realise the USD/Eurodollar was a weapon it could wield vs. China, and when it did we would see three key strings cut: trade; tech; and then capital flows. The first was evident during the trade war – which has not been concluded is likely to get far worse soon; the second is also abundantly clear on a variety of fronts, much to Silicon Valley’s chagrin; and potentially, now we see the start of that third step – because if the US does block this first USD50bn going in, other such steps will follow, just as they did on the previously unthinkable idea of US tariffs on China.
CNH is right to be selling off, albeit in a traditionally limited fashion, because if you don’t buy from China and you don’t help China up the value-chain and you don’t invest in China then China is not going to be getting much USD liquidity at all. The US hawks probably don’t get the Eurodollar iron logic there; they are likely just pressing buttons in anger. The outcome would be the same nonetheless.
I can hear the market bulls and technocrats of the world saying “But China has USD3 trillion in reserves!” Perhaps. Most think it’s far lower than that. And not earning USD means you have to dig into that stockpile. And when you do, the PBOC either has to contract the local money supply (because every USD is backed by 7.xx CNY on the other side of the balance sheet) or it just creates new CNY anyway and supply-demand sees CNY move sharply lower – as we have been seeing in all other EM FX. Looking at the drop in BRL, ARS, ZAR, TRY, etc., or even THB, this would be how we would get to the ‘unthinkable’ 8 (9? 10?) handle in CNY. That would also crush those other EM crosses in tandem - and AUD and NZD, as the former tries to navigate its own geopolitical spat with Beijing.
As we said two days ago, "with the Fed having taken over most US capital markets which have now lost most if not all of their discounting and signaling capabilities, keep an eye on that USDCNH: ironically, it may be the last true market stress indicator left."
Moves like tonight suggest that either someone knows something, that something big may be coming, or the algos are just doing all they can to trigger another stop loss domino effect.