China: Dollar may ease into the CNY6.50-CNY6.52 band - BBH

Research Team at BBH, suggests that China's new monthly cycle of economic data hits in earnest in the week ahead. 

Key Quotes

“Four pieces of data tend to capture the investors' attention:  foreign reserves (as a proxy for capital flows), trade, inflation, and new lending.  The broad picture that is likely to emerge is one of little improvement, but little evidence that the world's second-biggest economy is collapsing under the weight of debt that the pessimists have predicted.

If the shifting expectations of Fed policy are one of the key drivers of the investment climate, then the decoupling from China is another important feature of what has transpired in recent months. 

Investors also seem less sensitive to the yuan's movement.  Over the past year, the yuan has fallen in three phases.  The first two phases were disruptive to the capital markets.  Last August, in a couple of days, the dollar appreciated 3.8% against the yuan, and then in the November-thru-early-January period, the dollar rose 4.5%.  The third phase, which lasted two months, and appears to have ended last week, saw the dollar appreciate by 2.2%. 

The dollar peaked near CNY6.59 in the middle of last week.  It was sold after the US jobs data, finishing the week, just below CNY6.55.  In a softer dollar environment, we expect the yuan to track the dollar as if Chinese officials are reluctant to give the US any advantage for devaluing.  In a stronger dollar environment, the yuan may track the basket.  The dollar may ease into the CNY6.50-CNY6.52 band. 

We have argued that China's overcapacity in numerous industries is not simply a domestic problem, but it is a threat to stability of the global economy.  Judging from comments from Treasury Secretary Lew, the US recognizes the increased saliency of this issue.  However, it will be up to the next Administration to go down this path.  The Obama Administration's last Strategic and Economic Dialogue with China will be held in the week ahead.  It may mark a transition in the focus.

The US Treasury, even before the Obama Administration, had placed much emphasis on the yuan's exchange rate. In part due to its own successes in encouraging Chinese officials to accept yuan appreciation, and in part due to policy divergence that underpins the dollar, the yuan's exchange rate is of less urgency.  Also, the PBOC has intervened on both sides of the market, and this weakens the oft-cited accusation that China is seeking wholesale depreciation of the yuan.”