In China, the PBOC
Whose policy, previously
Consisted of planks
Instructing the banks
To buy more and more renminbi

Has seemingly now changed its mind
With prop trading now much maligned
Instead, what they seek
Is yuan, somewhat weak
And banks that object will be fined

Let’s face it, constantly harping on inflation is getting tiresome.  While it remains the biggest topic in the market, we have discussed it extensively, and in fact, until there is some clarity as to the next Fed chair, it is very difficult to even try to determine how the Fed will respond going forward.  The word is that President Biden will be revealing his nomination tomorrow at which point we can game out potential future scenarios.

In the meantime, we have seen large movements in some emerging market currencies, and we have heard about some potential changes in policies underlying one of the less volatile ones, the Chinese renminbi.  One of the more surprising features of the dollar’s rally since summertime has been the fact that the renminbi has actually strengthened about 0.6% while the euro has declined nearly 8%.  In fairness, the euro has many self-inflicted problems that have been underlying its recent weakness, but the dollar, as measured by the Bloomberg dollar index, has risen by nearly 6%, implying there has been a lot of broad-based dollar strength.  This begs the question, why hasn’t the renminbi followed suit?

There are several potential answers to this question with the likelihood that each has been a part of the process.  Remember, for a mercantilist economy like China’s, a weaker currency tends to be the goal in an effort to improve the competitiveness of its exporters.  So, acceptance of a stronger currency demonstrates other priorities.

If nothing else, China plays the long game, historically willing to sacrifice short-term economic performance for the sake of a longer-term goal, often a political one.  And one of the things China is very keen to achieve is de-dollarization of its economy.  Given the growing antagonism between the US and China, President Xi has determined his nation is better served by an alternative to the US dollar in as many areas as possible.  One of those areas is in trade with other developing nations.  To the extent that the Chinese can convince other Asian, Middle Eastern or African nations to accept renminbi in exchange for their products, rather than dollars, it both strengthens Xi’s grip on those nations’ economies as well as reduces his reliance on the US led SWIFT system thus preventing any interference by the US.  As such, it is incumbent upon Xi to insure that CNY is a strong and stable currency, the exact words the PBOC uses to describe the renminbi in almost every press release.

Now, while this may have been at odds with short-term potential benefits, Xi understood the long-term benefits of removing as much of the Chinese economy from the dollar’s global sphere of influence as possible.  And it seems, that a major tool used to help maintain the renminbi’s strength has been the encouragement of local Chinese banks prop trading desks to continue to buy the currency.  There have long been stories of the PBOC whispering in the ear of Chinese banks to do just that, with the implication that the PBOC would prevent any significant weakness.

But that was then.  It seems now that the ongoing malaise in the Chinese economy, where growth forecasts continue to slide and expectations for another 50 basis point RRR cut are growing, has the PBOC apparently cracking down on prop desks buying too much CNY.  They have been instructed to monitor client activity and keep it at more ‘normal’ levels.  Some see that as a tacit admission that the previous policy, which was never explicit, was in fact a reality.  In addition, much will be made of the fixing, which last night was printed 0.2% weaker than expected.  Now, while 0.2% may not seem like much, in a currency with historical volatility around 3%, it is a signal.  In addition, the PBOC indicated that it would be ready to allow a “more flexible currency”, their code for weakness.  This is not to say the CNY is going to collapse, just that the unusual strength we have seen over the past six plus months is likely coming to an end.  Be warned.

Turning to the rest of the market this morning, the situation is somewhat mixed, with equity markets showing both gains and losses, although bond markets are under universal pressure.  Starting with equities, Asia gave no directional cues with the Nikkei (+0.1%) little changed while the Hang Seng (-0.4%) and Shanghai (+0.6%) gave confusing signals.  It seems that there is a very large sell order making the rounds in Evergrande stock, which is weighing on HK, while Shanghai responded to the first hints of easing by the PBOC.  Europe, which was modestly higher earlier in the session, has drifted to a mixed performance as well with the DAX (-0.1%) and CAC (-0.2%) both a touch softer although the FTSE 100 (+0.1%) has eked out a gain.  In the absence of any data releases, it seems that traders are biding their time for the next big thing.  US futures, on the other hand, are all firmer by about 0.35%, despite talk of a faster taper by more Fed speakers late last week.

Bond markets, though, are having a rougher time of things with Treasuries (+3.3bps) leading the way, but Bunds (+1.3bps) and Gilts (+2.5bps) both following along.  OATs are unchanged on the day, although have spent the bulk of the session with modestly higher yields.  The thing about yields, though, is that they remain range-bound and have shown little impetus to trend in either direction.  This is a market waiting for the next central bank discussion.

In the commodity space, oil continues under pressure as the thought of SPR releases in a coordinated manner from a number of nations continues to dog the price.  NatGas (-5.4%), interestingly, has tumbled after a larger than expected build in inventories, something US homeowners will welcome.  In the metals space, gold (-0.2%) is slightly softer and copper (-0.6%) is feeling a bit more strain.  However, aluminum (+0.6%) and nickel (+2.1%) show that this is not a universal issue.

As to the dollar, in the G10 the story is mixed with AUD (+0.3%) the best performer while SEK (-0.4%) is the worst.  However, these appear to be flow related movements as there has been no data or commentary from either nation.  The rest of the bloc has barely moved, +/- 0.1% for most of them, as traders await the next big idea.  In the emerging markets, CLP (+3.0%) is the big gainer as yesterday’s presidential election resulted in the conservative candidate performing far better than expected and investors now hoping that the country will maintain its investment friendly policies.  On the downside, RUB (-1.3%) and HUF (-0.6%) are in the worst shape with the former feeling pain based on concerns recent troop movements near the Ukraine border will result in an invasion and potential further sanctions, while the forint is suffering despite a more aggressive central bank as inflation there continues to ramp higher.  Expectations are growing for yet another rate hike as the fear is they are falling further behind the curve.

With the holiday before us, data is all crammed into the first three days this week, and most of it is on Wednesday:

Source: Bloomberg

Consider that on the day before Thanksgiving, we are going to see some of the most important data of the month, and there will be relatively few people around.  If there is any surprise, we could see significant volatility.  In fact, for the week as a whole, the lack of liquidity is likely to result in a choppier market.  Keep that in mind if you need to execute anything of substance, but overall, the dollar’s recent rally seems likely to continue.

Good luck and stay safe
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