The Yuan has been a basis for Asian currency stability during past economic disaster and Chinese establishments propelled it up earlier this year to put off capital outflows and make a case for official reserve status at the IMF. China's policy moves to fortify exporters gradually and shoot the economic slowdown since 1990 heightens the risk of competitive currency devaluations as global demand wanes.
Complacent kneejerk response - Pay 1y CNH CCS at 3.50%, targeting 4.20% with a stop at 3.00%. We recommend investors to pay 1y CNH CCS at an indicative level of 3.50% (or where it settles down), which strengthens our existing view of a bear flattening trend in the CNH CCS market.
We like the 1y point on the curve because we believe that move will be led by a rise in FX forward points, while longer tenor CNY should reflect expectations of a further opening up of CNY-denominated assets, which we believe are likely to be the next steps scheduled down the line. Our target is 4.20%, slightly below the highs of 4.44% reached in March this year, while we set a stop at 3.00%.
Why 1Y Forwards: So far, market reaction to the reports has not been rather benevolent. The 1y CNH CCS shot up to 3.55% on the announcement, but then moved back to around 3.40-3.50% after the initial bounce. We believe that the market has the potential to move significantly higher from here once it fully digests this large change in China's FX policy framework.
