Chief Macro Strategist
Summary: The USD has weakened across the board and US long yields have risen to their highest level since June, unlike yield developments elsewhere. The strength in the Chinese renminbi needs a closer look as the fall in USDCNY accelerates, and the JPY is suddenly waking up this morning as USDJPY slips back below 105.00. Elsewhere, sterling complacency is creeping back into the picture.
Trading focus:
A breakdown of factors driving CNY strength
The USDCNY move lower has continued apace, even accelerating in recent sessions after China recently removed a policy that was intended to limit speculation against the currency. The latest move has taken USDCNY well below the early 2019 lows and more than 7% below the highs from this spring. The move is not an accident and is driven by both fundamental factors and by the fact that China would only allow a directional move of this scale to develop if it is in the interest of its longer term agenda. So, a few factors that are driving the CNY higher and could continue to do so unless China decides that enough is enough (perhaps more likely now that the broad CNY basket is reaching the top of its multi-year band – allowing it to move more than another two percent higher would be an even louder signal).
External stimulus and easing, relative domestic tightness – the PBOC has run a rather tight policy, to say the least, relative to the rest of the world, where the stimulus flood and chopping of interest rates has eroded fundamentals for foreign FX relative to the tighter domestic market in China and still very positive interest rates. As well, China had the luxury, as the world’s factory to allow foreign stimulus to provide powerful stimulus to its industries, whether for PPE or other goods.
Long term interest in CNY stability – as the US-China divide and rivalry is likely to deepen over the longer term horizon, China needs to move away from its dependence on the US dollar and exposure to the weaponization of the dollar in global financial infrastructure and trade and needs to provide a stable and strong CNY to excite interest in capital flows back into Chinese assets. China’s sovereign bond and other markets will need to deepen, especially the former, with significant progress in place on opening up its equity markets to the world.
Biden presidency to ease pressure on China – this may be secondary and I am less convinced on this narrative, but there is a widespread belief that a Joe Biden administration will put less pressure on China than a “second term Trump unleashed” scenario. We’re not convinced, but Biden has criticized Trump’s tariff approach.
Chart: USDCNH
The USDCNH has now traded below the 2019 lows and the broader CNY basket at its current level is basically at the highs of the range since the spring of 2018. If China is unwilling to allow the CNY to continue stronger versus the basket, a weaker US dollar would have to do the heavy lifting and China might offset some of the pressure on its currency by buying other currencies in its reserve mix (a very opaque situation there as Chinese official reserves data has not moved in years). Further downside from here might require more pronounced USD weakness from here rather than broad CNY strength unless China is looking for a stronger currency across the board even from these levels.
USD weak and US yields at long end rise to new multi-month highs
The US dollar weakened yesterday on the same day that US yields rose to new highs, with much of the latter coming somewhat oddly overnight in the Asian session. The narrative driving this is apparently that stimulus will either come now or massively so later (under presumed Democratic clean sweep as odd solidify in that direction) and that this will drive US inflation rates higher and real rates lower. Democrat House Speaker Pelosi and the Trump administration are still negotiating despite yesterday’s declared deadline (from Pelosi’s side) coming and going. I am not fully convinced that this is the case and wonder if some of the bond weakness is down to the rise in bond volatility driving technical adjustments in bond portfolio allocations, whether in risk parity models or in basic ratioed portfolios as recent risky asset volatility has seen no offsetting upside in US treasuries. On that note, I am still skeptical of a major USD directional move unfolding until we get to the other side of the US election.
The JPY wakes up this morning.
Normally, with higher US yields we would not be looking for pronounced JPY strength, but the fact that US yields are moving independently of yields elsewhere is a bit novel and weak risk sentiment is providing a JPY boost as well – although that particularly cylinder has fired erratically at best for many months now. Regardless, USDJPY is having a poke below 105.00 suddenly this morning, a move that keeps the focus on JPY crosses and one that clashes with the recent USD weakening move as the JPY and USD have been tightly correlated in most crosses for years.
Today’s G-10 rundowsn
USD – I am not sold on the narrative and afraid of taking away too much from this USD weakening move – wouldn’t take much for the greenback to spoilthe latest attempt at making a directional statement. Longer term is a different matter, but we need to get to other side of election and would prefer a partial options position for now rather than high conviction spot trades.
EUR – the euro running up to new highs, perhaps in part on the massive interest in the EU’s first social bonds issued directly by the EU in connection with the pandemic relief effort. Key technically for EURUSD to maintain above 1.1850 here to keep interest in a test toward 1.2000. But is market ready to get aggressive on a view on the USD before the US election result?
JPY – a look at yields ex-US suggests that the JPY need not sweat the rise in US yields unless we see global long yields dragged higher still. Risk sentiment is likewise strong in EM carry trades, etc., but we’ll watch this USDJPY situation closely if we stay below 105.00 as traders may be complacent on hedging flow risks if the JPY rally move here broadens.
GBP – sterling taking back about half of the recently lost terrain on the latest rhetoric and some sources suggesting that some of the UK position is theatre . The EU’s Barnier made flattering overtures on the UK’s sovereignty and said a deal is within reach in a speech this morning.
CHF – no spin here – below 1.0700 in EURCHF needed to merit attention, and really below 1.0600.
AUD – a popular short in the crosses as the RBA the only central bank able to gin up expectations of a significant shift in policy recently. That shift is likely large done. Further AUD downside would need a challenge to the reflation narrative, weaker global outlook, CNY to stop rallying, etc.. not to mention a technical break of 0.7000 in AUDUSD and 74.00 in AUDJPY.
CAD – a relative winner in the crosses, but not much more range to work with to 1.3000, which my hold until we get to other side of election to see if the USD bears kicks off then.
NZD – winning out relative to AUD on the RBA dovish shift, but hard time seeing significant room for further weakness in AUDNZD beyond another percent or two – watching 200-day moving average there at 1.0625 next.
SEK – the krona has held in well during the recent Covid-19 resurgence and weaker outlook now for the EU, but looking for significant further EURSEK downside now a tough call.
NOK – call us contrarian to further upside in EURNOK beyond 11.00 for now unless we get a new oil sell-off and more profound weakening in risk sentiment.
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