The Chinese yuan, after roiling markets earlier this year, is now back on the radar of currency traders around the world.
On Monday, the People’s Bank of China (PBOC) set the USD/CNY midpoint at 6.7690, the weakest level seen in six years, while offshore traded yuan, or USD/CNH, fell to the lowest level on record, largely due to ongoing US dollar strength as expectations for a US rate hike in December continue to firm.
While, as yet, it has not caused an adverse market reaction on this occasion, traders are watching movements in the yuan closely at present, remembering all too well the carnage it created in financial markets earlier in the year.
The panic then, as opposed to now, was fear about widespread capital outflows from the nation, sparking all kinds of concern that ranged from a potential large-scale devaluation to an imminent collapse of China’s financial system.
Neither happened then, but that’s unlikely to fill markets with much confidence, particularly should signs of renewed capital outflows be seen in the period ahead.
However, perhaps there’s a reason why markets are taking the latest bout of USD/CNY weakness in their stride.
As shown in this chart from Westpac, while the USD/CNY has risen to fresh six-year highs — indicating yuan weakness — it has actually been fairly stable against a basket of major currencies.
The red line in the chart is the USD/CNY rate, only it’s been inverted. The grey line is the CNY CFETS index, a trade-weighted valuation of the yuan against the currencies of China’s major trading partners.
As the USD/CNY has weakened in recent weeks, the CFETS basket has been stable against other major currencies.
In other words, the yuan has been weakening against the US dollar, not all currencies.
Perhaps this is the reason why markets aren’t too concerned about the recent rise in the USD/CNY, either that or recent Chinese economic data — including Q3 GDP — suggests that economic conditions in China aren’t deteriorating sharply as was the fear earlier this year.
However, should concerns about yuan weakness against the US dollar flare in the period ahead, it’s worthwhile remembering what the CFETS index has done so far in 2016.
The index has been falling steadily on a trade-weighted basis, at least until recently, and there’s been no concern expressed by markets, a point picked up by Martina Song, currency strategist at Westpac.
“It is probably under-appreciated that the yuan has been weakening quite steadily in trade-weighted terms since November, despite the mixed price action on USD/CNY since then,” she says.
A subtle reminder that if concerns about the yuan intensify in the period ahead, why weren’t they prevalent when it was weakening against a basket of major currencies over the course of this year?