12 Aug 2015
The renminbi is our currency, but your problem - UBS
FXStreet (Córdoba) - The People's Bank of China (PBoC) surprised markets by changing the way it determines the daily trading band for the CNY and sending the currency on a steep fall. The UBS analyst team explains what does this new policy regulation mean for major exchange rates.
Key Quotes
“China took another step toward currency liberalization by looking at the daily closing when deciding the mid-point for the next day's trading band. The change from a mid-point determined by the administration to a market-determined one allows markets to establish new trends in the exchange rate, as has been clearly demonstrated the last two days”.
“What does this new policy regulation mean for major exchange rates? We have changed our USDCNY forecast to 6.50 in three and six months and to 6.60 in 12 months. There is, however, a clear risk that it might overshoot these targets in the coming days”.
“The dollar is currently priced on expectations of US Federal Reserve rate hikes. Whenever these expectations weaken, the greenback does so as well. This is exactly what is happening currently. A weaker yuan is regarded as a deflationary global impulse, which delays the need for the Fed to raise rates. The euro profits marginally versus the USD, as it now incorporates safe-haven characteristics usually attached to the USD. At this stage of the cycle, the dollar gains when world growth looks strong and Fed rate hikes appear imminent. In all other cases the euro wins”.
“But will the Fed really delay raising rates due to a weaker yuan? We doubt it, although the markets have clearly taken that view. A cheaper yuan reduces the prices of US imports from China and potentially other Asian countries as well. It serves as a stimulus for the US consumer, just as lower oil prices do. If two external factors, oil and yuan, are acting like a rate cut, the incentive to hike rates should actually increase rather than decrease. Put another way: If oil prices were 50% higher than today and the yuan 10% stronger, would the Fed want to hike rates or leave them unchanged? We think most would agree that this state of affairs would slow the economy and cause the Fed to postpone rate hikes”.
“In short, insecurity about how the Chinese move will fully play out is weighing on the USD. However, once markets settle and investors regain confidence, the case for the USD strengthening remains good, in our view. We continue to forecast EURUSD falling to 1.05 in three months and USDCHF rising toward 1.03”.
Key Quotes
“China took another step toward currency liberalization by looking at the daily closing when deciding the mid-point for the next day's trading band. The change from a mid-point determined by the administration to a market-determined one allows markets to establish new trends in the exchange rate, as has been clearly demonstrated the last two days”.
“What does this new policy regulation mean for major exchange rates? We have changed our USDCNY forecast to 6.50 in three and six months and to 6.60 in 12 months. There is, however, a clear risk that it might overshoot these targets in the coming days”.
“The dollar is currently priced on expectations of US Federal Reserve rate hikes. Whenever these expectations weaken, the greenback does so as well. This is exactly what is happening currently. A weaker yuan is regarded as a deflationary global impulse, which delays the need for the Fed to raise rates. The euro profits marginally versus the USD, as it now incorporates safe-haven characteristics usually attached to the USD. At this stage of the cycle, the dollar gains when world growth looks strong and Fed rate hikes appear imminent. In all other cases the euro wins”.
“But will the Fed really delay raising rates due to a weaker yuan? We doubt it, although the markets have clearly taken that view. A cheaper yuan reduces the prices of US imports from China and potentially other Asian countries as well. It serves as a stimulus for the US consumer, just as lower oil prices do. If two external factors, oil and yuan, are acting like a rate cut, the incentive to hike rates should actually increase rather than decrease. Put another way: If oil prices were 50% higher than today and the yuan 10% stronger, would the Fed want to hike rates or leave them unchanged? We think most would agree that this state of affairs would slow the economy and cause the Fed to postpone rate hikes”.
“In short, insecurity about how the Chinese move will fully play out is weighing on the USD. However, once markets settle and investors regain confidence, the case for the USD strengthening remains good, in our view. We continue to forecast EURUSD falling to 1.05 in three months and USDCHF rising toward 1.03”.