Market Overview

20 November 2020

Chinese Yuan Becomes an Attractive Leader among Reserve Currencies

The Chinese Yuan, or Renminbi, is almost unmoved today as People's Bank of China (PBoC) kept its one-year loan prime rate (LPR) steady at 3.85% for the eighth month in a row since April. That is a major lending rate applied for corporate and household loans, when another benchmark, a five-year LPR, which influences the pricing of mortgages, remained at 4.65% per annum. The interest rates in China are now almost 0.5% lower than a year ago, but they still stand out as a bright spot against the background of near-zero, or even negative, rates of the central banks in other developed countries that are issuing reserve currencies.

Accumulation of some part of money even in one-year bonds of the Heavenly Empire brings the investment funds or individuals an income of more than 3% annually just on guaranteed coupons, compared with less than 1% on ten-year bonds of the U.S. Treasury or Australia, or just about 0.3% at the U.K. public debt. However, the coupon holders, or the owners of any Chinese assets, also benefit from the exchange rate, as USD/CNH was trading near seven yuan per dollar before the start of the pandemic, but it already fell below 6.55 by the middle of this week.

The Chinese currency has been the main beneficiary of the year in the Forex market thanks to something more than just financial flows rushing into bonds to seek a profitable interest rate differential. The international trade balance figures of China are very positive approaching $60 bln per month in terms of value between all exported and imported goods and services which is the biggest trade surplus in the world. It is highly in contrast with a deeply handicapped negative trade balance of the United States. Further inflating the U.S.-Sino trade gap was supposed to be limited by a deal signed in January and after several rounds of severe tariff wars, but the implementation of many parameters of the deal was delayed in practice due to the impact of COVID-19 on global demand and, therefore, on cross-border flow of commodities' trade.

The Chinese economy also was the first large economy to recover from a virus-induced slump. It still keeps some external influence risk, as the gain of one country in our interdependent world is closely tied to the success or misfortune of other partner countries, and it's impossible to sell to others more than they are able to buy. Generally, the Chinese industrial profit lost only 2.4% since the beginning of the year, and its gross domestic product even rose 4.9% according to official statistical data in October vs Q3 2019. Such fast and decisive recovery rates are not observed, of course, in Europe or the United States, where the economic indicators seems to remain on negative territory even by the end of 2021, and current business activity in November and December is going to be still subdued because of all those fresh second wave anti-virus restrictions.

Moreover, the United States is suffering from rising infections almost forced to introduce more and more restrictions. In New York City, its Mayor Bill de Blasio first decided to close schools and then said indoor dining could be closed in the next week or two. This definitely discourages the retailers as limitations are returning just when the U.S. heads into the Thanksgiving holiday, which usually was a time of big family gatherings. The governor of California announced on Thursday that he imposed a curfew on social gatherings and other so-called "non-essential' life activities trying to curb an alarming surge in infections while the authorities are waiting for the nationwide vaccine distribution maybe in March or April. COVID-19 related hospitalisations across the United States jumped by nearly 50% in the last two weeks, threatening the recovery of the world's largest economy as cities and states began to impose lockdowns.

On the European continent, the virus is spreading more slowly, and if the situation at least improves before Christmas, then European business activity could resume in a less restrictive way. In such a scenario, even a possible rally in EUR/USD would be justified, which is what some investors may bet as the single currency is trading in between 1.18 and 1.19 for the last several days, which is at a moderately higher level than the medium height of the last two months. But, of course, this modest move cannot be compared to the growing popularity of the Yuan, after USD/CNH fell from the vicinity of a 6.80 level, where it was at the end of September, to its current 6.53-6.60 range.

Most U.S. companies are in a good mood about doing business in China in case the democratic nominee Joe Biden comes to the White House, a survey by the American Chamber of Commerce in Shanghai finds. Leaving out the political probability of a possible change of the administration in Washington, 54.8% of 124 company leaders said on Friday they are “more optimistic” and 8.1% are “much more optimistic”. Only two companies signalled they are more pessimistic about doing business in China now.

Joe Biden just said yesterday, during a meeting with a group of governors in his hometown in Delaware, he is not supporting the ideas of "punishing" China, but the point is just to make sure China understands "they've got to play by the rules". He also announced that this is one of the reasons why his team wants to re-join the World Health Organisation and the Paris Climate Accord "on day one". But what else the economic rules of the game might be for China, none of the Biden team has yet given specific recipes. Most only agree that trade wars may subside under Democrats.

However, in terms of the U.S. Dollar's exchange rate against the Chinese currency, it has already declined gradually in the course of the year, when a Republican team was sitting steadily in the White House. Moreover, it could happen due to some non-public agreement between the negotiators from Donald Trump and the Chinese financial block not to allow any Renminbi weakening. Just maintaining the status quo with the same or even cheaper USD/CNH exchange rate helps to rebalance U.S.-Sino trade, so it could be a part of the arrangements. And any changes in this regard, as well as non-compliance with a previously made deal, may potentially lead to unpredictable movements in the exchange rate in 2021.

From the point of view of purely financial fundamentals, the hard working "money printer" of the U.S. Federal Reserve also works for the long-term weakening of the U.S. currency, and therefore for a stronger Yuan. All the plans, or more talks for now, about the next stimulus package, with a size of 10% of the U.S. GDP or so, are surely very good to boost the domestic American economy, but the same stimulus would even dilute further the Dollar money supply to an even more rarefied condition.

Under the current White House administration, this was also the case, but at least the potential damage for the U.S. Dollar-based system promised to be compensated later by a partial reversal of trade flows and an expected return of some production to the United States territory due to tax cuts. But it remains a mystery, if not a very big problem, how the Democratic enthusiasts could have avoided a really dangerous level of a possible devaluation of the U.S. currency if they are not ready or just don't want to press China's economy anymore.


Disclaimer:

Analysis and opinions provided herein are intended solely for informational and educational purposes and don't represent a recommendation or investment advice by TeleTrade.


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