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Stresses in Intra-Asia FX - Global Exchanges

FICC Podcasts April 26, 2022
FICC Podcasts April 26, 2022

 

In this episode, we discuss noteworthy FX moves over the past week and what they may mean going forward, with particular emphasis on the Chinese renminbi and Japanese yen.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Greg Anderson:

Hi, welcome to episode 41 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. For this week's episode, my co-host, Stephen Gallo and I will be talking about noteworthy FX moves over the past week, what they may mean going forward, with particular emphasis on the Chinese Renminbi and Japanese yen. The title of this episode is Stresses in Intra-Asia FX.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London based FX strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York based FX strategist. I'm Stephen's co-host.

Stephen Gallo:

In each weekly podcast, like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets, like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, it's affiliates, or subsidiaries.

Stephen Gallo:

Okay, Dr. Anderson, let's get the ball rolling again. It's the 26th of April, 2022. We're coming towards the end of an interesting month in FX. For once in a long while, we are seeing examples where FX markets are driving moves in other asset classes and not simply taking direction from other asset classes. The obvious example being the move in the RMB just recently, but we'll touch on that a bit later. But given this pick-up in FX volatility, and I haven't even mentioned the yen yet, but given this pick-up in volatility, I want to go back to our previous podcast's content. That was episode 40 entitled, Does the FX Market Need an Intervention? Is what we asked.

Stephen Gallo:

Well, according to last week's G7 Finance Ministers and Central Bank Governor's Official Statement, there's no need at all. We couldn't find any reference to exchange rates or cooperation on exchange rates at all in the entire statement. In order to dig through some of this, why don't I pass the mic over to you, Greg? Before I do, I just have one question. If we were questioning the need for some type of intervention, do you think policy makers were doing the same thing behind closed doors last week?

Greg Anderson:

So Stephen, just to lay out the meetings in a bit more detail, the deputy heads of G7 and G20 Central Banks and Finance Ministries, normally gather one to two days prior to their bosses, so they would've been doing that as we were podcasting last Tuesday. They would've been working on what's called a draft communique or now it's simply just referred to as a joint statement by the G7, and then the G20 just refers to it as a statement from the host country, which this year is Indonesia.

Greg Anderson:

So I'll point out that as we were podcasting last week, Dorian was making its run above 129. And although it wasn't mentioned in the statement, I would still venture to guess that the move was being discussed, along with the risk benefit profile of intervention that we alluded to in last week's podcast. One of the things I said last week, was that the G7 would probably only agree to a joint intervention at Japan's request if the BOJ were also willing to back it up with a policy shift, like scrapping the Yield Curve Control Mechanism and/or a so-called micro-rate hike.

Greg Anderson:

From the fact that the G7 didn't even reiterate its can language that FX markets should reflect fundamentals, and the chart moves are undesirable, Yada Yada, it would seem that Kuroda wasn't willing to make any commitments from his end. So the conversation just stopped there. Anyway, that's just supposition on my part. I will note that dollar yen seems to have somewhat turned all on its own over last week. Thanks to a risk off tone in global markets that has caused the money market to take a few basis points of Fed rate hikes out of the curve, and has also pushed oil five to 10% lower than where we were a week ago. But this risk off tone Stephen, it's emanating from an interesting place, China.

Greg Anderson:

And I will note that from early March until last week's moment of extreme weakness for the yen, that the yen had weakened about 10% against the Renminbi over the span of a month. I can imagine that Chinese officials probably weren't very happy about that yen depreciation, and maybe they happy that the G7 and G20 decided not to do anything about it. So just looking at the timing of things, G7 and G20 statement drafts were presumably prepared on April 19th ahead of final release on April 20th. And then on April 20th, we got the break above 640 in onshore dollar China that quickly steam rolled into breaks of 650, and then in dollar CNH, 660 over the next several trading sessions. So Mr. Gallo, is this all a coincidence or a strategic reaction, do you think?

Stephen Gallo:

Yes, interesting and complex Greg. And what I'm going to try to do is my best to make it digestible. You know, this Greg, because you've looked at China for a long time. We can never really isolate one reason for moves in China's currency. It's a closely managed currency, and so is the balance of payments. So we don't know exactly why Chinese policy makers chose this point in time to allow the currency to move, to depreciate, in the same sense that we don't know exactly why Chinese policy makers allowed the RMB to appreciate against the currencies in the CFES basket by 7% over the past year. Why did policy makers allow either of those moves? And I think the short answer, this is my view, is that the RMB is a flexible currency, but it's flexible on China's terms. And when China wants it to be flexible and when China wants it to respond to certain fundamentals.

Stephen Gallo:

So I think one reason is not the only reason, but one reason for the RMB appreciation from the peak of the pandemic in 2020 until roughly Q2 of this year, it was a combination of current account and financial account inflows. And with that, very loose Fed policies and abundant dollar liquidity certainly helped not lease because loose monetary and loose fiscal policies in the US boosted Chinese exports to America, but the stampede into Chinese assets in the wake of ultra cheap money due to the pandemic was also notable, I think.

Stephen Gallo:

So in that environment, what those flows, policy makers let the currency appreciate firstly, to reflect increased demand for RMB and the buildup of foreign currency liquidity onshore, and secondly, as a means of tightening financial conditions a bit through the exchange rate. We've also got to remember that Chinese government bonds were included in the FTSE world government bond index late last year and combined with or across border RMB settlement over time, which is what we're expecting. A lot of that flow should become permanent.

Stephen Gallo:

Now, Greg, you asked about the depreciation in the yen against the RMB and while we're at it on this issue, I also mentioned the depreciation of the Korean one in view of the strong trading links between China, Japan, and South Korea. I think maybe policy makers had decided that a seven to 10% annual gain in the trade weighted RMB was enough, and that the RMB had to sort of realign with the decline in those other Asian currencies year to date. But I think the more important drivers of the move in the RMB have been the flows. It seems likely that COVID lockdowns led to a deterioration in the trade balance this month, April, we should see that data come in over the next week or so. And we know from looking at the FX settlement and sales data that non-residents investors have been trimming their exposure to RMB portfolio investment assets.

Stephen Gallo:

Why are they doing this now? I would say perhaps risk compensation is a big part of it. China's economy is clearly slowing, bond yields globally have been repriced higher. It's probably a long shot, but maybe China's yield will do that at some point too, and until now the RMB has been exceptionally strong. So it's time to trim exposure. What we haven't seen, this is as far as I can see, is signs of acute financial stress in Chinese markets. I don't think that's what's driving these outflows.

Stephen Gallo:

And just as a note about diminishing returns in mid 2020, the rate differential between the US tenure treasury yield and the Chinese tenure government bond yield in local currency, was 244 basis points in favor of the CNY. It's now just eight basis points in favor of the CNY after briefly turning negative earlier this month. So for a short period of time this month, the yield on the US 10 yield was above China's.

Greg Anderson:

So Stephen, you did seem to agree with me that China at least allowed the first three to 4% of the move, even if they didn't cause it per se. But as an observation, I would note that China can't really devalue its currency very much at least against its trading basket, because once dollar RMB starts to move, everything else react. So in this go around over the last week, I'll just say that onshore seeing eyes down about 3% on a week, over week basis, but Aussie's down 4%, narrows down 2%, and Malaysian ringgit also down 2%, etc. So at any rate, after the dollar China move had gotten to the point where it was influencing other exchange rates and maybe global equity prices too, then Chinese officials came in yesterday with this required reserve ratio cut on dollar positions. Do you have anything you want to say about that policy shift?

Stephen Gallo:

Honestly, probably more questions than answers Greg, but here's what I suspect. I suspect in view of the flows I noted above if I'm interpreting the data correctly, that the balance of FX and CNY liquidity on shore has either shifted or it's expected to shift if the trade balance deteriorates and as investors sell their RMB assets and buy foreign currency. Now, assuming that puts a strain on dollar liquidity, which is on shore, it makes sense that the local banks would be instructed to inject more of it, hence the reduction in the reserve requirement ratio.

Stephen Gallo:

One thing I did note before was the buildup of FX liquidity on shore in 2020 and 2021. And for example, you can see that by looking at corporate FX deposits with commercial banks, but I should also note that it was so large that buildup what PBOC did in 2021, was increase the triple R on FX deposits with commercial banks two times in order to preserve FX liquidity within the banking system, prevent a sharp increase in FX lending on shore or just currency mismatches. Anything else that could potentially leave the financial system short to foreign currency, when the supply of foreign currency is no longer as abundant.

Stephen Gallo:

And the issue of abundant foreign currency liquidity, that's why the impact and the advent of Fed quantitative tightening is going to be very important for the FX space for a number of EM currencies.

Stephen Gallo:

One other thing to add Greg, on this policy shift we were talking about as the triple R was cut by 1% this week, offshore CNH rates at certain parts of the curve did in fact rise. So we saw a loosening of dollar liquidity on shore, which was offset by a tightening of CNH liquidity offshore in a sense. And that made it more expensive for investors to be short of CNH. I saw this as one of the first indications of the PBOC putting the breaks on RMB depreciation. Will it be the last? I'm not so sure about that.

Greg Anderson:

Let me just jump in and say that for FX markets, it rarely makes sense to fight Fed. And it makes even less sense to fight the PBOC. So I guess, with where I'm at, with the way that the China centric risk off tone has halted the move higher in dollar yen for now, I'm still not convinced that the move in dollar yen is over. I think we may yet see a break above 130 as we get through a non-action BOJ meeting later this week, and then a 50 basis point Fed rate hike, and QT inauguration next week. So I personally think it makes sense to be looking to get long dollar yen on its present 127 handle. I would just prefer to do it if possible on the rebound, rather than on the downstroke so to speak. My views are pretty similar on Aussie, USD. So on a 71 handle, I think it's a bargain and I would be looking to get long, but I would also prefer to see it consolidate for a day or two before entering that view.

Greg Anderson:

I do think that we will get a hawkish RBA next week. And with that we'll see the inauguration of a tightening phase and Aussie USD I think it'll make its way back up toward 75 cents over the next three months or so. So combine those two things and we get long Aussie yen as a trade idea. And that pair has corrected about 5% over the past few days, but I think it'll go right back to where it was, if dollar MB will just hold still and consolidate for a while. So that's my favorite FX market play for now. What about for you, Stephen? Does anything stand out to you?

Stephen Gallo:

Well, Greg, since you can be wrong in this business, as much as you can be right, it's important to mention the good calls as well as the bad ones. And for the record, my favorite trade, which we discussed in episode 39, was to sell cable above 130, that worked out fairly well. I'd like to be able to take a position in Euro Sterling, preferably would a bit of downside exposure, but I think the right thing to do would be patient and wait to see how the Para Trades around its 200 day moving average for a few sessions. If I were to go short Euro Sterling, it would be more of a carry trade rather than a fundamentally bullish view on Sterling. So let me make that point clear. I am not bullish on Sterling.

Stephen Gallo:

And then of course there's dollar China. You mentioned earlier, Greg, not to fight the Fed or the PBOC. And you're absolutely right, that if I had to make a judgment on whether the full RMB decline was over or that it still had room to run, I'd probably judge that it has a bit further to run. China needs inflows, and exchange rate has to adjust to reflect that, especially with yields in China so low. But I would rather gain exposure to dollar RMB by waiting for an opportunity to sell the pair. So on the downside rather than to get involved with the momentum now. In other words, when the RMB is depreciating. In my view that is rational, because I think, the Central Bank, the PBOC is likely to be a lot more defensive on regulating the speed of the move in the RMB on the downside rather than when it's appreciating. So 660 in dollar CNH, it looks like it will hold for a bit, but let's wait to see how the next month or so of event and flows play out

Greg Anderson:

Great comments. And that was a great Sterling call from a couple weeks ago. My Kiwi call from that same episode, not so good. At any rate, I think that we have covered what we needed to.

Stephen Gallo:

But Greg don't beat yourself up. You were way ahead on the end call this year and that was a big call and it may get bigger. Right. Let's wrap it up here as you indicated, Greg, thanks listeners for putting up with us again and we hope you'll do it again for our next episode. We appreciate it a lot. Bye for now.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts bmocm.com/global exchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by puddle creative.

Speaker 3:

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Speaker 3:

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Greg Anderson Global Head of FX Strategy
Stephen Gallo European Head of FX Strategy

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