China Can’t Stop Big Currency Moves

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

It has been another busy 24 hours in the foreign-exchange market with GBP falling to fresh 5-year lows and CAD at 13-year lows against the dollar. But the big story continues to be China. Overnight, China took fresh steps to discourage speculators from selling the yuan off-shore by driving up margin lending rates to staggeringly high levels. The Hong Kong Interbank Offer Rate or HIBOR surged from 13.4% to 66.8%, a record high. Before the weekend, the HIBOR rate was a more modest 4%, which marks a 16-fold increase from those levels. The HIBOR is volatile but this kind of volatility can’t come from anything except for central-bank intervention. In other words, before the weekend it was relatively cheap to borrow and sell the yuan but today, it has become exorbitantly expensive. Existing short sellers will be squeezed out of their positions, which is exactly what the PBoC aims to achieve. The gap between the on-shore CNY and off-shore CNH hit record levels last week and after intervening in the on-shore yuan on Monday, the PBoC turned its focus to the off-shore currency.

Chinese banks are the largest liquidity providers for CNH and they can determine how much it costs to borrow the currency. China’s SAFE confirmed that they asked banks to limit yuan outflows. In directing the banks to limit the supply of the yuan and raising the cost of borrowing, they made it extremely costly to sell the off-shore currency, which is not subject to the same trading band as the on-shore CNY. The gap between the CNY and CNH rate narrowed significantly as a result and at one point, CNH was stronger than CNY. But that did not last for long as market dynamics took over. Tuesday’s steps stabilized the on- and off-shore currency along with Chinese equities, but lets see how long the PBoC can keep this up because China is burning through its reserves and intervention in a freely traded currency -- even one like the CNH which tracks CNY -- is rarely successful.

China remained in focus Tuesday evening with trade numbers scheduled for release. Economists were looking for a smaller surplus along with weaker imports and exports. Given the recent volatility in the markets, we would not be surprised if the Chinese government massaged the data. The Australian and New Zealand dollars traded slightly lower and the sustainability of those losses will be driven by Tuesday night’s report.

Stability in the Chinese markets has meant stability for some major currencies and equities but China can’t stop all of the big moves in currencies as sterling dropped to its lowest level since June 2010. The sell-off was driven by a surprisingly large decline in industrial production. In November, IP fell 0.7%, its steepest fall in almost 3 years. That drove the annualized pace of growth from 1.7% down to 0.9%. Weaker growth in Europe, the slowdown in China and unseasonably warmer weather weighed on energy output. The Bank of England won’t be happy with the latest report as it gives them even less reason to consider raising interest rates this year.

USD/CAD continued to rip higher, rising to its strongest level since April 2003. The currency pair hit new 12- and then 13-year highs 5 out of the last 6 trading days. The latest milestone was reached during the North American trading session, around the same time that oil prices broke below $30 a barrel. With a light Canadian economic calendar, loonie traders would be best served by keeping their eye on oil as the currency moves in lockstep with the commodity tick for tick.

The U.S. dollar traded higher against most of the major currencies Tuesday as stocks and Treasuries moved higher. Only a handful of second-tier economic reports were released and there was nothing inspiring in those reports. Small business confidence ticked up slightly, economic optimism as measured by IBD/TIPP edged higher but not by as much as economists anticipated. According to JOLTs, job openings increased in November. The Beige Book report is scheduled for release Wednesday and hopefully it will shed more light on the wage situation in the U.S. as well as the pace of recovery. For the most part, U.S. policymakers remain optimistic. We heard from Kaplan who is a new member of the FOMC (non-voter) and he sees no great bright spots in the world except for the U.S. He believes the stock market can still have an unhealthy year and from now to March, there should be enough data to make a decision on raising interest rates again. No new comments were made by Fed Vice Chair Fischer but Lacker’s comments were hawkish. He said “I hope we’re not behind the curve” on rates and believes the Fed is likely to need at least 4 rate rises in 2016. He is not a voting member of the FOMC this year.

The euro traded slightly lower versus the greenback after a suicide bomber set off an explosion in Istanbul. That raised renewed concerns that more attacks could hit Europe in the coming months. No data was released from the Eurozone and ECB member Villeroy’s optimistic comment that the economy is improving fell on deaf ears. We expect EUR/USD to range-trade for most of the week. Considering that there are no major European economic reports scheduled for release and U.S. retail sales are not due until Friday, EUR/USD should remain confined between 1.07 and 1.1040.