Yuan In Focus Awaiting US Rebuttal

Submitted by Eleanor Creagh, Australian Market Strategist at Saxo Bank

Summary: Asia equities continue to trade higher sweeping aside the mounting tensions between the US and China, instead focusing on the perceived positives which have driven risk assets in recent weeks. Namely economic optimism surrounding reopening economies, slowing COVID-19 case growth and expanding central bank balance sheets, with the pledge to continue to backstop asset prices as and when needed.

The S&P 500 again closed below the 3000 level and the 200 DMA, as late session news regarding potential sanctions on Chinese officials and entities involved in enforcing the proposed new security law in Hong Kong crossed wires. President Trump’s comments were vague, but stipulated a “powerful” rebuttal would be enforced by week end. However, in today’s Asia session, despite a bumpy morning, traders once again have swept aside geopolitical tensions and the aggressive afternoon ramp in US futures into European/US cash open is back. E-minis have pushed through the 3000 level with a helping hand from Japan’s fresh stimulus package, even as Senator Rubio confirms in tweets that the sanctions will be going ahead if China passes the Hong Kong bill.

US indices are at the upper limit of recent trading ranges, but risk sentiment remains strong and this could help fuel a continued breakout as shorts are covered around these crucial bull/bear markers and the psychological 3000 level. As we have previously noted, risk assets are not being driven by pervasive uncertainties and reopening realities. The hope trade is firmly rooted in abundant liquidity and the promise of more if necessary, along with the speculative flows of retail traders driven up the risk spectrum via the lack of alternative (TINA) and the expectation that rates will remain low for an extended period. The sharp rebound of March lows in turn drives continued speculative behaviour, as the fear of missing out (FOMO) becomes a driver and in this paradigm markets remain biased to the upside. However, valuations are stretched and geopolitical tensions continue to mount which could upset the apple cart, despite the optimism surrounding reopening economies, slowing COVID-19 case growth and expanding central bank balance sheets, with the pledge to continue to backstop asset prices as and when needed.

On the speculative retail investor flows we have previously pointed to via Robinhood positioning comes some more data from Envestnet Yodlee. According to their data aggregation, “Trading stocks was among the most common uses for the government stimulus checks in nearly every income bracket”. Signalling investors conditioned by the central bank put to “buy the dip” are going “all in” on a snapback in economic activity. It seems TINA and FOMO are set to remain as key drivers in equity market activity. In an environment where central banks backstop asset prices and yield is nowhere to be found, retail investors are paying up for the optionality of earnings growth and dividends.

Risk reward favours buying volatility on the downside, whilst in the short term we continue to respect the price action and technical flavour driving the rebound. Markets have run ahead of reality in pricing a speedy recovery; however, a wide range of consumer and economic probabilities still exist at this juncture. Liquidity buys time, not solvency!

With a lot of optimism embedded in risk asset pricing the latest in ramping tensions between the US and China, leaves markets somewhat complacent to the mounting geopolitical risks. Particularly considering, as we have discussed earlier this week, the tough stance on China may prove a crucial part of Trump’s re-election strategy. Recent survey data shows a shift in sentiment toward China, a cause for concern as the upcoming elections in the US may provide increased impetus to elevate geopolitical frictions if they play to US voter support (which will remain a rolling calculus). On that basis, USDCNY bears watching closely as a barometer of China’s intent, with depreciation potentially being a catalyst for renewed risk-off sentiment.

 CNY/CNH In Focus

USDCNY our barometer of China’s intent and proxy for the state of US/Sino relations continues the steady decline. The currency appears to be anticipating the US response following China’s strike on Hong Kong’s legislature, and potentially autonomy. The PBOC set the central parity rate today at 7.1092, 52 pips stronger than even the lowest estimate, signalling some push back on the CNY depreciation. However, one day does not a trend make, and the offshore (CNH) has continued to weaken in today’s session and is pushing above the March highs, 7.1653, trading up to session highs 7.1763 as tensions between the US and China continue to ratchet higher. The all-important 7.20 level (last year’s trade tension high) is in play as CNH continues to decline.

As we wrote earlier this week, the PBOC has previously made it very clear the Yuan is not a one-way bet and do not want a disorderly panicked move. However, the slow and steady depreciation is in play. The yuan will weaken to offset renewed tariff risk but also remains under fundamental market pressures. As the $CNY exchange rate approaches 7.20, angst will be on the rise but the manner of the depreciation will determine the resultant risk asset response. The more disorderly, the greater the fallout.

The Aussie dollar continues to be driven by strong risk sentiment and the re-opening narrative, trading in lockstep with the S&P 500. However, we remain on high alert given the war of words extending between not just the US/China but also China and Australia. Typically, the AUD has had a strong positive correlation with moves in the Chinese currency and has traded as the China proxy. However, more recently, the local unit has been closely tied to the rebound in risk appetite and the S&P 500 has won the correlation battle. Given that we remain on high alert for the market narrative change and the re-opening optimism is well reflected in the AUDs sharp rebound off March lows, upside should be limited for the Aussie dollar. Should the rising geopolitical tensions begin to turn risk sentiment and the Chinese currency continue to decline, then the Aussie dollar should shake the shackles of the S&P 500 and turn lower.