BNY Mellon: CNY Signals

15 jan 2019

By Simon Derrick – Chief Currency Strategist

By Simon Derrick – Chief Currency Strategist

As noted in mid-December, there are occasions when forward outrights can provide a useful barometer of pressures building within a managed FX regime.

This proved the case within the European Exchange Rate Mechanism back in the 1980s and early 1990s and, arguably, for USD/CNY over the past decade and a half.

The usefulness of forward outright pricing as an indicator of changing sentiment was made apparent again in the run up to the end of 2018 when the USD/CNY NDF market indicated that investors were becoming increasingly convinced that the authorities would be able (with the support of the Fed) to prevent the USD from appreciating beyond the line in the sand at CNY 7.00.

Since then, the recovery in sentiment towards the CNY has been sufficiently robust that one-year NDF points have been hovering close to zero since the start of the year.

To put this into context, since March 2012 - the point at which the seven-year rally in the CNY against the USD finally began to lose momentum - there has only been one very brief period when the one-year NDF points turned even briefly negative.

In other words, the past six years have been characterized by consistent expectations that the CNY would weaken over the subsequent 12 months from wherever spot was at the time.

This then is a market that has been at least considering the possibility that the CNY might actually strengthen against the USD in 2019.

Importantly, while markets can be caught unawares by events - the de-pegging by the SNB in January 2015 being an excellent example - the NDF market has had a history of getting trend shifts in spot CNY roughly right.

Given this, it was therefore interesting to note a story that emerged out of Beijing on Friday. MNI (quoting a “source close to the PBOC”) reported that the bank did not want a sharp appreciation by the CNY and that the current rally could be capped at about CNY 6.7 to the USD.

Coming after one of the sharpest weekly declines seen in the USD against the CNY since the mid-1980s this is understandable enough.

However, the continued pressure on the forward outright points might have provided additional impetus in getting the message out in a particularly timely manner.

There is one additional point to be made about what, arguably, looks like an attempt to persuade the market that the USD will trade in a CNY 6.7 to CNY 7.00 range for the foreseeable future.

Back in July 2008, concerns had grown within Beijing about the economic outlook. With priorities shifting it rapidly became apparent that the authorities were looking to effectively (even if unofficially) re-peg the CNY against the USD.

This they duly did for the next two years. The interesting thing about this is that the level the authorities chose to re-peg at was around CNY 6.82.

This also just happens to be the average price for USD/CNY since the start of this year.