The Future of the Renminbi

If there has been one sure bet in financial markets over the last few years, it has been on an appreciation of the Chinese renminbi against the U.S. dollar.

The appreciation has been slow but steady. After a few years of managed appreciation, the renminbi was repegged during the 2008 crisis. In response to considerable pressure from the United States, the peg was removed  and the currency was re-'floated' in June 2010. However, the Chinese authorities continue to set the daily closing value and the renminbi has appreciated less than 7% against the U.S. dollar since then. Reputable estimates of the size of the undervaluation are as high as 70% (here), but my read of the 'main-stream' estimate has been about 20-30%.

 

This intervention has caused considerable furor in the United States. It seems like every six months (or is it a year?) there is a bout of political grandstanding surrounding whether the Treasury will be forced by the Senate to include China on their list of currency manipulators, which would pave the way for the U.S. government to impose trade sanctions. Of course, due to the symbiotic nature of the trade relationship between China and the United States, this never ends up happening, but the posturing appears to have started again (here).

The market however, sees things quite differently. The renminbi forwards market is currently pricing a depreciation of the currency against the U.S. dollar over the coming months.

In other words...

The best explanation I can come up with is that the market consensus is waking up to the Jim Chanos version of the Chinese growth story - economic expansion fueled by unsustainable credit growth which is financing enormous investment in overcapacity (here, starting at the 7 minute mark). While the renminbi forwards have moved in a manner consistent with the recent sell-off in Chinese equities and commodities, I was still quite surprised to see this pricing in the forward markets. Any divergence between these asset classes should be closely monitored moving forward.

Other News

The Canadian dollar closed above par with the US dollar for the first time since June 2008 today.  Next stop $1.05?

Also, the market has spoken on the big fat Greek band-aid offered by the EU.  Some commentators tried to talk up massively over allotted 6 and 12 month T-bill auctions.   Is over allotment surprising, considering that the EU/IMF has package has effectively guaranteed Greek financing for the next 12 months?  Oh did I mention the yields were extremely rich at 4.55 and 4.85 percent respectively?  Isn't the current ECB rate at 1%?
After dropping significantly Monday, Greek spreads to bunds and CDS spreads widened Tuesday and Wednesday, closing above Friday's levels Wednesday.  This is the market screaming from the clock tower that while addressing the prospects of a liquidity crisis, the announced package does nothing to address the (much larger) solvency issue.  More on why the Greek situation is hopeless to come this weekend.

Why Financial Journalists Should be Trained in Economics

Today the Canadian dollar reached parity with the US dollar for the first time since June 2008.  Back then, oil (one of Canada's primary exports) was circa $140/barrel.  As has been the case for all currencies, it has been a pretty wild ride since then.  In response to this development, Reuters ran a story on the Canadian dollar's rise  today.  After an overview of the more conventional causes of the Canadian dollar's rise - expectations of divergence with American monetary policy and strengthening commodity prices - the article identified Friday's US payrolls number as the most recent driver of the Canadian dollar's rise, on the basis that this was a sign of strength in Canada's largest trading partner.

I could understand how this might strengthen the Canadian dollar versus a 3rd country's currency, but using improving American fundamentals to rationalize the bullish moves in CAD/USD is nothing less than a failure of financial journalism.

Bank of Canada's Next Move?

Lately there has been a slew of good economic data out of Canada. Employment, retail sales, housing starts, you name it, they have all beat expectations this month.

This trend continued today with some surprising CPI data. Core CPI came in at 2.1% versus expectations of 1.7%. For those of you not fully in touch with what's going on up North, allow me to fill you in. On 21 April 2009 the Bank of Canada (BoC) reduced the overnight rate to the effective lower bound of .25% and pledged to keep it there until the end of Q2 2010, "conditional on the outlook for inflation". The BoC also effectively put their money where their mouth was by "rolling over a portion of its existing stock of one- and three-month term Purchase and Resale Agreements (PRAs) into six- and twelve-month terms at minimum and maximum bid rates that correspond to the target rate and the Bank Rate, respectively." Since then, at each Fixed Announcement Date (FAD), the same (now tiresome) message has been repeated. To paraphrase somewhat, it is as follows: 'the outloook for inflation remains steady, therefore we aren't going to hike until the end of Q2 2009, conditional on the outlook for inflation.'

Well, now the game has changed. In their quarterly Monetary Policy Report, published in January, the BoC forecast core inflation to average 1.6% in Q1 and 1.7% in Q2. If this were to materialize, it was implicit that rates would stay on hold. With core CPI in January coming in at 2% and now a 2.1% print in February, this forecast is beginning to look sanguine. The BoC shrugged off higher than expected inflation in their press release after the FAD on 2 March, stating that it was "the result of both transitory factors and the higher level of economic activity". With inflation being more sticky than expected and the next FAD scheduled for 21 April, there should be some vigorous debate behind closed doors at the BoC over the next few weeks. Governor Mark Carney (formerly of Goldman Sachs for all you conspiracy theorists out there) holds the veto at FADs. He is highly regarded in Canada for his handling of the crisis and is surely aware that a lot of the BoC's credibility rests on the right decision on 21 April.


Addendum:
The BoC has repeatedly fingered the strengthening Canadian dollar as a downside risk to inflation. Ironically, traders have been bidding up the Canadian dollar of late in expectation of a rate hike by the BoC. If this momentum trade continues, the feedback on inflation could provide Governor Carney the inflation data necessary to eschew the very rate hike that said traders are looking for.