Made in China Is Not Bad – USDCNY

China is wasting no time searching for a missing planeload of Chinese nationals and widening their currency band all at once, right before the Crimean vote today.

March 15 (Bloomberg) — China will widen the limit for the yuan’s daily moves against the U.S. dollar, easing exchange-rate controls as policy makers encourage greater use of the currency in global trade and finance.
The yuan will be able to trade as much as 2 percent on either side of a daily central bank reference rate, compared with the current 1 percent, the People’s Bank of China said in a statement published on its website today. The change will take effect on March 17. The band was last widened in April 2012 from 0.5 percent, and before that from 0.3 percent in May 2007.
The move underscores pledges from the government to make the exchange rate more market based and promote freer movement of capital in and out of the country for nvestment. The People’s Bank of China in February included an “orderly” broadening of the yuan’s band among its 2014 policy goals, and it said in November that it plans to end “basic” intervention in the currency market.

My hedge fund friend once told me he only traded CNH once a year. No point having a position in it for the rest of the time. He probably does not remember divulging his trade secret for that was when he was in a respectably mid sized fund and now he has gone places and into the big time.

I will not say I am a genius because I said this … just last week…”Don’t hate me for going against the consensus but USD/JPY is a sell to target 100.50 and USD/CNY should challenge 6.20 again. ”

Yet it looks like this time it is different.

History of band widening.
Mar 2014 +/- 2%
April 2012 +/- 1%
May 2007 +/- 0.5%
Jul 2005 (unpegged) +/- 0.3

The market is taking 2 sides to this.

1. Priced in vs surprise.
I am astonished that this move has taken some market pros by surprise although others argue that it is priced in. Fx advisory folks have been caught off guard, missing out on the hints dropped along the way after last week’s annual session of the National People’s Congress (NPC), the Communist Party-controlled legislature.

2. Sell AUD vs Buy AUD
The initial reaction would be to sell AUD rightaway when Wellington comes in tomorrow morning, so set those alarm clocks and hold your breaths. Yet some are of the view that the correlation between AUD and CNY has broken down as evidenced in the AUD weakening last year while the CNY was strengthening away.

Thus it may not be as clear cut as our brains are wired to believe.

3. USDCNY direction
All analyses suggest higher USDCNY, past 6.20 for starters as speculators get flushed out, but undecided on the final trajectory. BoFA, Deutsche and gang are for the CNY to emulate the SGD Neer basket, band, crawl system, tracking inflation and flow driven via FDIs and interest rate differentials.

Rule of Thumb : band widening when currency is strong = weakening.

HSBC is holding on to their call for USDCNY at 5.98 by end 2014 but the rest are less sanguine, expecting market forces to dictate given that the CNY is no longer seen as undervalued.

4. Chinese Equities and Credit Markets
Again, first reaction would be a pull back but for how long and how far is really a big question mark. The result may be a small correction given the market positioning and anticipation of this band move and exporters may regain ground.

The opposing school of thought would purport that many corporations are latched onto sizeable CNY carry trades and could be staring at big losses which could lead to deleveraging and potential capitulation that the PBoC (with US$4.0tn FX reserves, 20% reserve requirement ratio (RRR) and a 67% loan-to-deposit ratio (excluding shadow banking)) is well equipped to handle.

Adding to this stress is already the cracks appearing in the credit markets which are seeing further threats from 1. the declining value of commodities pledged as collateral (Copper collapsed) and 2. default risks in wealth management products (like the China Credit Trust bail out we saw last month).

The conclusion is that China is enacting reforms to allow a greater market role in the CNY rate which will bode well in the long run for greater CNY use, confidence and convertibility in global markets.

The role of speculation is not dead because China will be less predictable than Singapore who has effectively committed to eternal strengthening as long as inflation exists and China does not have Singapore’s semi annual schedule to tweak the band. Thus, widening and tightening can both exist.

One thing for sure is that people will start paying more attention to domestic rates and the balance of payments situation in China as the country juggles a monetary and fx policy, a novel and technically impossible endeavour.

As of 2011, Wikipedia lists China’s largest trading partners as follows.

USD leads as number 1 if we include Hong Kong USD peg in the picture. This is followed up the EUR and then, surprise, ASEAN and Japan. We are in for some implications !

And there is talk on the amount of TARNs (Target Accrual Redemption Notes) sold in private banking space, choking on leverage and possibly sparking a mini riot next week with phone lines abuzz for margin calls.

All this says is that they are serious. There are reforms and CNH will be integral in the global marketplace and in reserve books in the future. So let us be circumspect and keep an eye out for the opportunities ahead.

I have written some not so nice things about China in the past and what a big farcical contradiction of a place it is. Kept quiet last year as I started to notice that the rest of the world is not much more inspiring. I still do not want to live there. But I am beginning to think that Made In China is Not That Bad (still no go on the food yet).

Setting a 6.30 target for USDCNH to buy some. Good luck and get some sleep before Wellington opens later on tonight.