Markets seem to be celebrating what Barack Obama called the ‘constructive step’ of abandoning the Chinese Renminbi’s (Yuan) peg against the US dollar.
On 19 June, China announced their major shift in monetary policy that has been in place since mid-2008. However, given the ensuing relatively cautious tone by the Chinese, will this positive step be a short-term move or will it help push asset classes higher in the medium to longer term?
How others view China’s unpeg of the Yuan
Certainly you can make a good argument that the move improves relations with the US after mounting pressure by Timothy Geithner’s team and other G20 members. They have been advocating a stronger Yuan for months saying it gave the Chinese an unfair advantage against global trading partners. By effectively preventing their currency from rising against the Greenback, the Chinese were boosting their exporters at the expense of their importers (as a rule exporters perform better when their domestic currency is weak). Certainly the recent GDP print at 11.9% for the first quarter was testament to how well exporters have performed.
The more cynical traders will probably see the change of tact by the Chinese as merely political, and will likely look for selling opportunities if the market over reacts.
The move has been seen as a small political win for Timothy Geithner. However, it also signals that the Chinese are bullish on their economy, with their central bank saying ‘the upturn of the economy has become more solid with the enhanced economic stability’. This is likely to improve risk appetite in the short term.
What is also apparent is that we may see a change to domestic led demand; a stronger Yuan gives companies more international purchasing power and strengthens household incomes. In theory, we could see China’s appetite for Australian products increase, which looking longer term should support the miners and the Australian dollar. As the Chinese Vice President said, ‘trading relationships with Australia are becoming more innovative’. So for longer-term traders, this shift in policy is a positive one.
It is also worth mentioning that some economists, notably Nouriel Roubini, have suggested that the Yuan may even weaken against the US dollar as a result of the changes. Mr Roubini hinted that if the Euro continues to decline ‘the Renminbi would have to be allowed to depreciate relative to the dollar’.
Currency markets
Looking at the debt markets, we could see US treasuries under selling pressure in the short term. We have seen Chinese holdings of US treasuries recently increase to $900.2b, a move which indicates their confidence in the US economy. However the market may be concerned that the move for more flexibility in their currency will lead to a slower accumulation of US treasuries.
Given the potential longer-term shift in demand from the Chinese, the currency markets will take central focus. This could not only give risk associated currencies a boost, but it could also see appreciation in currencies with the largest share of exports to China – namely Australia, Taiwan, Korea, Brazil and Indonesia. Japan may also benefit, but the Yen is trading with risk aversion, so these developments may actually work against the Yen. The Euro has been making a push higher recently and the focus here will be bank stress-test results and further bond auctions. However, given Europe is actually China’s biggest export destination, this may work against the currency (though increased risk appetite may be an influencing factor).
Commodities
One of the key concerns that investors have had is whether China’s cooling of their economy, due to increasing inflation, will cut the demand for commodities. Given the rampant growth in their economy, notably their property market, we’ve seen an increase in interest rates and the reserve requirements that banks must hold, with the aim to reduce lending. These events have had traders pressing the sell button. What is positive for commodities and traders that are holding material stock names is that a stronger currency is deflationary. Therefore, an appreciation in the Yuan will mean it is less likely that we will see further monetary measures by the Chinese.
Base metals should effectively be supported by the potential appreciation in the Yuan (as it adds to the Chinese consumers’ purchasing power, giving them scope to increase demand). This will no doubt see sentiment push commodity prices higher in the short term, for the likes of copper, nickel and zinc. However, it is also worth noting that the end demands for commodities are dependent on exports, so the net effect is actually quite uncertain.
Gold bulls will also not be too upset by this development. With the gold price closing in on $1300, it is widely expected this will have little bearing on how gold trades. As it stands, funds are buying gold as an alternative currency to the Euro or US dollar. Traditionally, gold has had an inverse relationship with the US dollar, but this has recently not held true. Whilst traders have little faith in the Euro and with the Fed having a ballooning balance sheet, Gold is seen as the alternative currency.
Yuan’s appreciation likely to be gradual
What is important to remember is that whilst the peg against the US dollar has been removed, any appreciation by the Chinese authorities is likely to be gradual in nature. According to Goldman Sachs, it may only go up as much as 5% by the end of the year. Whilst some officials maintain the Yuan is significantly undervalued, the Chinese will move off their own steam and this event is not likely to be a huge catalyst for risk assets in the longer term.
What is positive though for the Australian dollar and our economy is that we could see an increase in exports as China looks to boost domestic demand and fixed asset investments.
Short-term traders should see this as a positive development and whilst US officials will no doubt see this as a small victory, it reinforces the Chinese as ‘team players’ in the global recovery that is taking place.
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Updated: 21/06/10
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