Courtesy of Also Sprach Analyst:
Late last year, I suggested that should the economy weakens considerably the “endgame”, or perhaps one of the tools (to put it more mildly), is for China to let the Yuan weaken.
The reason is that the soft peg between USD and Chinese Yuan should limit the ability for the central bank to perform monetary policy independently. As a result, should the economy weakens considerably, and if the US dollar is strong as it is now (and indeed, as expected here), there is a limit on how much the People’s Bank of China can ease policy. At the end, there will be no other option but to let the Chinese Yuan fall.
Now, it appears that the market has started to realise that. Reuters is reporting that apparently traders are no longer expecting the Yuan to rise. Instead, they are expecting a measured depreciation against the US dollar. Indeed, some are setting up short positions:
A debt crisis in the euro zone has of late developed into a political problem as well, with risk aversion driving the dollar index to its highest since September 2010 on Wednesday, casting doubt on whether Beijing can afford to let the yuan to continue to strengthen against the dollar.
More significantly, China posted a stream of weak economic data for April, which caused the People’s Bank of China (PBOC) to hastily reduce banks’ reserve requirement ratios, injecting liquidity into the economy. The news and the ensuing cut exacerbated concerns over the health of the world’s second-largest economy.
As a result, traders say banks and their clients started to erect yuan short positions during the dollar rally this month.
Here, I have noted a number of times that the pace of Chinese Yuan appreciation has slowed, if not stopped altogether. Well actually, the Chinese Yuan is now 0.64% weaker than what it was by the end of last year. The updated chart below clearly shows that USDCNY has done nothing since late last year.
The fact that the Chinese Yuan (or Renminbi) is doing absolutely nothing for the best part of the year tells you that the Chinese government is worried about growth, such that they are no longer hoping a measured appreciation. So don’t be surprised when it falls, because it will.
Please be warned, however, that I am not saying that the currency will collapse. At least at this given time, I am not expecting that.