An In-Depth Look at the Yuan

In-Depth, Look, Yuan, Currency Analysis, fx trader, forex

There were two dogs that did not bark this year. The Japanese yen, which despite negative interest rates and an unprecedented expansion of the central bank's balance sheet, strengthened 15% against the dollar. The yen has been the strongest major currency, and the third strongest currency in the world behind the high-yielding Brazilian real, recovering from last year's drop, and the Russian rouble, aided by a rebound in oil.

The other dog that is not barking is China. In August 2015, and again at the start of is year, the decline of the yuan and weakness in Chinese equities reverberated around the world. It was even cited as a factor influencing the timing of the Fed removing accommodation. Since early this year, the yuan has continued to depreciate, and Chinese shares are among the worst performers. Yet it has not been a disruptive force.

The Shanghai Composite has fallen 11.5% this year. MSCI Emerging Market Index has gained about 14%.  MSCI Asia-Pacific Index has advanced roughly 6% this year. MSCI's World Index (developed markets) is about 4% higher on the year.

China's reserves have fallen by about $134 bln in the first nine months of the year. This understates the capital outflow as China also recorded a $134 bln current account surplus in H1 16 and a trade surplus of $146 bln in Q3. Brad Sester of the Council on Foreign Relations, estimates that China may have experienced outflows of $95-$100 bln in Q3. As China sells reserves, it is selling US Treasuries. The latest country breakdown covers the month of August. US data, which is not necessarily comprehensive, estimates that China sold $33.7 bln of Treasury Securities in August after selling a combined $25.2 bln in June and July.

Without complicating the picture by attributing Belgium's activity to China (as some want to do since China may use clearer and custodian there), US data shows China having divested US Treasuries in six of the first eight months of the year. In the past, and occasionally still, one can read pundits claiming US dependence on China funding its deficit. China's sales of Treasuries has not prevented a decline in US yields this year. The 10-year yield finished last year near 2.27%. It is 50 bp lower.

The yuan is off 4.2% this year to trade at six-year lows against the US dollar. The dollar rose 4.65% against the yuan in 2015 after a 2.5% gain in 2014. The dollar had fallen against the yuan after officials abandoned the peg in 2005. Yuan rose against the dollar every year from 2005 through 2013.  During the period around the Great Financial Crisis (mid-2008 to Q4 2010), it appears that officials had re-pegged the yuan. Since bottoming in January 2014, just below CNY6.04, the dollar has appreciated nearly 12.4% against the dollar.

Why aren't the developments in China having a greater impact on global markets? We suggest there may be several reasons behind the seeming disconnect.

First, we suspect that the surprise and uncertainty over intentions led to an exaggerated market response in the summer of 2015 and earlier this year. The Chinese stock market, for example, is dominated by retail funds and has little relationship to the Chinese economy. China stocks have also stabilized. In July and August 2015, the Shanghai Composite fell 14.3% and 12.5% respectively. It fell 22.6% in January 2016. Since March, it has moved no more than 3.6% net-net in any month. Similarly, in August 2015, the dollar rose 2.7% against the yuan. Its monthly moves have been much smaller.