FxWirePro: CNY’s further depreciation likely to stimulate trade-war risk scenario

After US President Donald Trump caused a stir amongst EU members during his visit to Europe last week when he referred to the Union as a (trade policy) “foe” and even shock up Sterling with his comments on Brexit, he will meet the Russian President Vladimir Putin in Helsinki today. Anyone will be aware by now that the world order has changed fundamentally from what we once knew. What matters for the FX market is whether there is any reason to become more risk averse, be it for reasons of security or trade policy. For that reason, it will be interesting to see whether the two alpha males will get on or whether there will be any verbal attacks. If the latter was to be the case the safe havens like dollar, yen and franc will appreciate again short term.

In another week dominated by a barrage of political & trade headlines, the focus was on the accelerated depreciation of the CNY, which has posted a 3.5% cumulative decline over the past two weeks: basically equivalent in magnitude to the August 2015 shock devaluation.

We argue that the macro backdrop against this CNY move is very different than in mid-2015, and thus the earlier episode offers a poor template to how broader markets might react. While the primary framework remains one that is tracking risks around US-China trade escalation, the increased sense of the risk of a Chinese currency response adds several overlays. This includes exacerbation of a potential regional macro spillover and the possibility that Trump rekindles his erstwhile aversion to a strong dollar.

In trade risk events, next week will be busy with both the likely implementation of $34bn tariffs by both the US and China, as well as Canada’s retaliatory tariffs on $13bn of US imports. Meanwhile, not too far off on the horizon are US actions on autos, the first of which could come as early as end July.

Hence, looking ahead, the trade tensions have significantly increased the downside risks to the economy. Moreover, the domestic issues, such as debt problems and property bubbles, remain the key challenges for China’s economy. That said, a weaker CNY can be expected and by many perceive and measure the 3.5% depreciation in RMB in the second half of June was nearly unprecedented, perhaps only comparable in magnitude to the August 2015 one-off devaluation of the RMB which sent shockwaves through global markets. Courtesy: Commerzbank & JPM

On hedging grounds, we advocate initiating longs in 3m USDCNY forward contracts, as these derivatives contracts help foreign traders manage the forex risk by locking in the future exchange rate and predetermined date on which they would make a foreign exchange transaction. Thus, by using FX forward contracts, investors can: protect costs on products and services purchased abroad protect profit margins on products and services sold abroad lock-in exchange rates as much as a year in advance.

Currency Strength Index: FxWirePro's hourly CNY spot index is inching towards 81 levels (which is bullish), while hourly USD spot index was at -29 (mildly bearish) while articulating (at 13:33 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex