US Dollar Rises against Chinese Yuan after PBOC Ramps Up Stimulus with Quasi-Quantitative Easing

-USD/CNY aims for new highs following PBOC stimulus.

-PBOC commences extraordinary form of quantitative easing.

-Analysts cite "trade war", warn of more CNY devaluation ahead. 

© GovernmentZA, image Reproduced Under CC Licensing

The People's Bank of China (PBOC) is now increasing stimulus to the Chinese economy at a time when central banks elsewhere in the world are doing the opposite.

The latest stimulus has been described by one analyst as a form of quantitative easing (QE) - a process by which central banks infuse struggling economies with cheap cash in order to stimulate growth and lift inflation.  

"To be clear: the Chinese central bank will be buying (more) corporate bonds and China is doing more QE as the rest of the world’s major central banks march toward tightening/policy normalisation," says Sue Trinh, head of Asia FX strategy, at RBC Capital Markets.

China's central bank is reported to have instructed commercial banks to increase lending to all companies but particularly those which are struggling. It is believe to have pledged to reimburse lenders for these loans and may actually pay banks that lend to more embattled companies.

This makes the latest stimulus measure an extraordinary form of quantitative easing. Typical quantitative easing would see the PBOC buying bonds directly in the market. 

Some are saying the intervention reflects the Chinese authorities' desire for a cheaper Yuan, given that QE forces interest rates lower and so tends to prompt currency depreciation. Falling rates are bad for a currency because they deter international capital flows, which tends to go where returns are rising.

"Markets have been looking for a sign that China is unhappy with the move in the CNY/H, but if anything, China is actually giving the green light to send CNY/H weaker - we’ve had no verbal intervention, lame efforts to slow the RMB’s descent and announcement upon announcement of monetary and fiscal easing," Trinh says.

"The Chinese Banking and Insurance Regulator (CSRC) has asked financial institutions to "earnestly implement" plans to help reduce financing costs for small firms, Trinh warned, in a note to clients Thursday. "Banks will receive double the amount of MLF loans for investment in corporate bonds rated below AA+ (they will get 2CNY for 1CNY loans/investment)."

A recent spike in debt-defaults by Chinese companies, shown in the chart below, is thought to be the main reason for the intervention. Although some, including Trinh, have been watching the Chinese currency closely and are suspicious about the PBOC's supposed motives. 

Above: RBC Capital Markets graph showing Chinese debt defaults.

Moreover, the policy is to at least some extent self-defeating because many Chinese businesses have debt denominated in US Dollars. Those debts will become more expensive and difficult to service as the Yuan weaknes, although a weaker currency will help China's economy cope with President Donald Trump's trade tariffs. 

China Relaxes Currency 'Fix'

The Yuan is not a free-floating currency as the Chinese authorities 'fix' exchange rates before trading begins each day, and the currency is not permitted to fluctuate above or below the stated level by any more than 2%. 

On Thursday, the PBOC raised its 'fix' above 6.7 for the USD/CNY rate, which gave the impression the PBOC wants a softer Yuan and prompted traders to sell the currency.  

Above: USD/CNY rate shown at daily intervals.

China could be using a weaker Yuan as a weapon in the trade war against the US, says Paul Gambles, co-founder and group co-director of MBMG Investment Advisory.

"If America Doesn't Wake Up the Yuan could devalue to over 7.50 to the Dollar," says Gambles in an interview with Bloomberg TV.

The US recently announced a range of tariffs on American imports of Chinese goods. In the middle of June the Yuan was actually stronger relative to most non-Dollar currencies, but since then it has devalued by more than 3.0%. 

"I think what we are seeing now is very politically motivated. There are very clear signals out there to America that they really need to back off on these tariffs. There is a trade war going on here and America is being very brutally beaten," says Gambles. "It suits China" to have a weaker Yuan, for although the current account surplus is high there has been a slowdown in the economy which would be helped by a cheaper Yuan."

Gambles warns that if the US does not back away from a "trade war" with China then the Chinese authorities will continue to push the currency lower, bringin 7.0 and 7.50 into sight for the USD/CNY rate.

"The Yuan doesn't move in isolation, if you look at the Thai Baht it tracks the Yuan very, very closely, so America is scoring a massive own goal in allowing the emerging markets to do with their currencies," Gambles concludes.

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