Last night the Senate passed a bill that would punish countries that manipulated their currencies (like China).
Already China has fired off a warning retaliatory shot by weakening the yuan.
In a new note out this morning, Goldman Sachs explains why the whole thing is madness.
Long story short: China is already strengthening the yuan at a fairly good clip. What’s the idea behind this kind of provocation?
Perhaps the most important development of the last couple of weeks has been the notable trade-weighted appreciation of the CNY, which occurred on the back of broader USD strength, in particular vis-à-vis other NJA (Non-Japan Asia) currencies. The reason for this move has been quite simply the fact that the Chinese authorities have kept $/CNY at roughly unchanged levels at a time when broader risk aversion translated into broader depreciation of EM and NJA currencies.
During September, the trade-weighted CNY appreciated by a whopping 6%, the largest appreciation since the global financial crisis in 2008. Almost all of this was matched by an equivalent Dollar move, which also appreciated by about 6% on a trade-weighted basis.
When trying to make longer-term comparisons, we need to take inflation differentials into account in our real TWI. The latter shows that the recent 6% appreciation puts the real effective CNY now only about 4% below the all-time highs reached in early 2009.
The extent of the outperformance in the region, which is one of the key reasons why the CNY is so strong on an effective basis, can even be observed in the CNH spreads as a result of significant unwinding pressure in the USD/CNH spot. As of market close on October 11, the spread between onshore CNY spot and offshore CNH spot has widened again to the largest we have seen since the ‘creation’ of the CNH. Some offshore exporters also worry that that CNY would embark on a depreciation trajectory, causing many to convert their CNH to USD.
China trade legislation in the U.S.
Against the backdrop of notable trade-weighted appreciation in recent months, it is remarkable that U.S. policymakers continue to push for foreign exchange-related legislation to potentially impose countervailing duties on China.
Though we do not expect this legislation to become law anytime soon, as Alec Philips explained in a US daily published earlier this week, it certainly highlights that actual CNY appreciation is only one parameter affecting a complex political process. In particular, there seems to be an interesting link between other trade-related legislation passing Congress and a decent dose of CNY-related opposition. Much of the protectionist threat therefore seems to be political posturing rather than actual concerns.
To be sure, bilateral imbalances remain large and will likely be highlighted by three key data releases this week. Both China and the US will release their latest trade balances (for September and August, respectively), and China will also post its latest quarterly FX reserve numbers (consensus expects $3.3tn).
Overall, some political pressure towards faster CNY-TWI appreciation will therefore likely remain in place, and the historical pattern suggests that the Chinese authorities will accommodate this pressure at least partly – even if the authorities worry about an export slowdown because of weaker underlying growth in major economies. Increased $/CNY volatility in recent days may already be a hint, though NDF markets continue to price $/CNY appreciation – i.e. CNY weakness – over the next 12 months.
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