China's Offshore Yuan is Bossing the US Dollar Around Today
The Dollar came under pressure on Thursday January 5 with most commentators pointing the finger for the falls at the release of the US Federal Reserve's FOMC minutes for the move.
Dollar weakness has allowed the EUR/USD exchange rate to jump off the support zone at 1.04 and move into the 1.0550s in a notable relief move.
“The Dollar is softer across the board with the Bloomberg DXY suffering its biggest one day correction since early September. Reading through last night’s Fed minutes of the December meeting there seemed very little that could be read as negative for the dollar,” says Chris Turner at ING in London via a note to clients seen by Pound Sterling Live.
While some of the move can be attributed to the FOMC, there is a more significant driver at work - China's offshore Yuan.
“Most of the losses accrued in Asia and have little to do with last night’s FOMC minutes, which left markets unchanged. Spillover from an overnight collapse in USD/CNH (from 6.90 to 6.80 intra-day) and further squeeze higher in offshore rates (overnight almost 40%) are the more important driver,” Adam Cole, an analyst at RBC Capital Markets tells Pound Sterling Live.
Cole believes this is likely to be a temporary phenomenon, and he sees trend CNY depreciation as an ongoing theme.
The CNY is China's Yuan while the CNH is the offshore version of the currency.
Each weekday morning the PBOC sets a rate for CNY and the market within China is then allowed to trade within 2% of this value.
The offshore CNH’s rate is meanwhile not controlled and is decided almost entirely by the markets.
Due to PBOC’s massive influence, the CNH tends to stay within close range of the domestic CNY rate, but, as is the case at present, sometimes there is a deviation.
CNH is sharply firmer after a short squeeze in both the spot and forward markets.
The impact the move has had on the broader Dollar complex, “does highlight the vulnerability of very long USD/G10 positions to external shocks, however positive the US domestic story,” says Cole.
“The forward curve is massively inverted, (O/N CNH implied yields at 62%) which is not just a story of scarce liquidity ahead of Jan 27 Lunar New Year. Scope for further squeeze suggests USD/CNH & $/Asia can correct lower,” says ING’s Turner.
Why the CNH is so Volatile
What’s behind the big move?
While transparency is low, analyst Allan von Mehren at Danske Bank gives his take on the matter:
- China has been very concerned about rising outflows and feared an acceleration in January as many – including ourselves – have focused on the resetting on 1 January of the USD50,000 quota that all Chinese citizens can buy every year as long as the use of the money does not violate the capital control rules.
- It seems that China has tried to act pre-emptively and put a stop to the depreciation of CNY versus USD, as this could risk fuelling more outflows – as was the case in January last year. China’s best weapon to stop depreciation is intervention in the offshore market and to tighten liquidity. This pushes up offshore money market rates and thus the cost of shorting CNH.
- As many hedge funds and other investors have been short CNH going into 2017 on the expectation that outflows could pick up, we believe there has been a big short position in the market that has been squeezed by the rise in the cost of selling CNH. As these investors scramble to close positions, demand for CNH is moving up and is pushing money market rates up even more. It also pushes more investors to run for the door in the trade.
CNH Effect to Fade, Eyes Turn to US Data
Because the CNH-inspired move in USD is therefore largely technical in nature, the weakness is already starting to fade.
Indeed, direction should soon start coming from more traditional corneres.
The Dollar faces a heavy economic data calendar over the next 48 hours, so expect further twists and turns.
The ADP employment and initial jobless claim figures will attract some attention ahead of the important December jobs report, which is due out tomorrow.
ADP is forecast by economists to read at 179K.
The ISM non-manufacturing index is set to be released, and analysts expect this to show a continuation of the strong growth signals.
However, as the index jumped to 57.2 in November, while the Markit PMI service index stayed more or less unchanged, some see a downside risk to the ISM non-manufacturing index in December due to volatility, and estimate the index declined to 55.9, which is still solid.
Consensus estimates forecast a reading of 56.6.
Of course the big event will be the release of US non-farm payroll data out on Friday afternoon London time.
A reading of 178K is forecast by economists.