BNY Mellon: The Aerial View: CNY – A Forgotton Risk

Oct 17, 2018

By Simon Derrick, Chief Currency Strategist, BNY Mellon

While tensions around Brexit and the Italian budget might have eased slightly over the past two days and oil prices appear to be stabilizing, risk sentiment overall remains cautious.

This is just as apparent from the sharp rally seen in the price of gold since the middle of last week (a further echo of price action seen back in October 1987) and the continued sensitivity of price movements in USD/JPY to movements in US equity indices. It’s therefore worth asking what risks remain.

One risk that might have been forgotten a little bit by the broader market in recent days is the CNY. However, with US Treasury yields beginning to creep higher again, President Trump hinting at further tariffs on Chinese goods and the CSI 300 trading at close to its lowest level since the summer of 2016 (despite a recovery in equity indices elsewhere), the continued risk of a fresh bout of weakness cannot be ignored.

On the face of it, should this happen then the answer would be for the PBOC/SAFE to return to actively using its foreign exchange reserves to fight against currency weakness.

However, as the authorities discovered in the months following the August 2015 devaluation scare, this approach is not without risk. Indeed, it’s arguable that this (along with events in Japan in November 2011) helped highlight quite how ineffective intervention can prove to be for anything other than smoothing purposes. 

It’s also worth considering quite what has happened since late August when the PBOC reintroduced the use of a counter cyclical factor in the CNY mid-point fixing as part of its broader efforts to contain CNY weakness.

While it’s certainly true that the CNY remained relatively strong over the next few days, the story since the end of August has been a slow, steady grind lower for the CNY, leaving it over the past week at almost exactly the same level against the USD it stood at two months ago.

In short, the best that can be said is that the authorities have stabilized the situation for the moment.

Given the relatively low likelihood that the FOMC will be prepared to sway from its current path unless significant market unrest emerges, as well as the fact there is little sign of the US backing down in the trade war (reflected in part by the poor performance of the CSI 300), there would therefore appear to be a perfectly reasonable chance that CNY weakness could re-emerge from here.

Why does this matter?Although it’s easy enough to see the direct impact that volatility in Chinese equities and the CNY could have, it’s worth recalling how significant Chinese policy shifts (or refusal to shift) have proved since 1998 when Beijing refused to devalue the CNY and was, as a result, credited with having helped to bring the Asian currency crisis to a close. Subsequent examples include the July 2005 de-pegging, the July 2008 informal re-pegging and the devaluation scare of August 2015. In short, what happens to the CNY can have implications well beyond regional markets.

Given the relatively fragile risk sentiment evident in global markets, this suggests keeping a close eye on Chinese markets in the coming weeks.