Forex Comment Aug 21

Yuan breaks above key 6.9 level to dollar, highest since January

World-beating outperformance to continue, next target 6.85

Yuan breaks above key 6.9 level to dollar, highest since January
Xi and Trump in happier times. Trade talks may be set to resume. File photo by AFP.

(ATF) The People's Bank of China (the central bank) on Friday morning set central parity of the yuan against the US dollar at a strong 6.9107 ... and yet it under-estimated the strength of the Chinese currency's upward momentum.

At 9:40am, the CNY touched the 6.9000 level for the first time since January. Shortly thereafter, the CNH, the offshore deliverable CNY, broke the key 6.9 level and climbed to 6.8936.

Since then, both CNYs have come back in some. The CNY traded at 6.9187 at 7pm HK time, with the CNH at 6.9171. 

But there is no evidence from the standpoint of fundamentals or political event risk that the upward momentum of the Chinese currencies has peaked. This goes for both the yuan and the Hong Kong dollar, which trades right up against the upper limit of its trading range with the USD, at 7.7501.

The most fundamental of currency fundamentals – the interest rate differential between the US and China – was at its widest since 2018 last week, which favours the long yuan carry trade.

The same goes for the US-Hong Kong rates differential and favours the long HKD trade.

Given the vast outperformance of the Chinese economy over the US and the prospect that the growth differential will become even more pronounced, it is clear that Chinese rates will stay ahead in the game.

Meanwhile, the US dollar continues to stay on the weak side, as no one knows whether or when the current Covid wave in the US will come under control or become even more virulent as schools reopen and colder weather sets in.

The USD traded in the 92.5750 - 93.2320 range on the dollar index (DXY) today. There's nothing in the US economy, let alone US politics, that has any chance of pushing the greenback higher.

New unemployment claims rose again. The number of Americans filing for benefits rose by 1.1 million, according to a report on Thursday, well above market expectations. That trend cannot change until the Covid battle turns.

Political risk to the yuan? It's pretty clear from the news overnight on a resumption of US-China trade talks that a desperate US President Trump is unlikely to throw away his last election trump card, of having China buy US foodstuffs.