Cross-posted from Inventing in Chinese Stocks.
CBS MarketWatch: Watch out: Yuan plunge is possible, warn analysts
Bank of America Merrill Lynch Global Research warns in a new report that it sees a “non-negligible” risk that China’s government will surprise the market by slashing the value of its currency.
To reach this conclusion requires not just a hard-nosed appraisal of China’s economic numbers, but also to consider the unthinkable, namely that Beijing might actually lose control of the situation.
…By borrowing from the thinking of Nassim Taleb of “Black Swan” and “Antifragile” fame, it argues that such attempts to engineer stability have ended up creating a highly fragile situation.
Although on the surface China looks stable when you consider its consistently high growth rates, limited bad-debt levels and a pegged currency and capital controls, the instability comes from leaving no means to release tension. The implicit backing of debt by the state means this has obscured normal price and risk discovery.
The theory continues that when everyday volatility is suppressed, this can lead to hidden, unobservable risks which can unravel violently and without warning.
“Even though China continues to have a large trade surplus and the yuan’s interest rate remains above that of other currencies, increasingly diverse and complex factors may cause greater volatility in the country’s cross-border capital flows,” it said.
It also said that the yuan’s exchange rate may remain fixed in the short term as an emergency measure to deal with internal and external shocks, but that the rate needed to change in the long-term to prevent imbalance and distortions in the economy.
In “What Risks Do A Sharp Depreciation In The Yuan Bring?”, a UBS analyst reckons: (人民币急剧贬值会带来哪些风险)
On the yuan, given the volatility of its features (a month dollar / yuan implied volatility of about 2-3%), tail risk refers to the depreciation of the dollar against the 5% or more.
Paging Taleb, tail risk in the yuan is a bad week for any other currency.
The article goes on to discuss how China was unwilling to depreciate in 2008, but may be willing now:
First, by the end of 2008 when the global financial system on the verge of collapse and cause serious crisis of confidence. Therefore, China’s central bank would like to see the dollar / yuan remained stable, international investors have avoided adding more uncertainty. Today the situation has been different: monetary policy differences are mainly due to a stronger dollar overall. In this case, China’s central bank, or consider the necessity to deal with the fall devaluation. Second, compared with 2008, is currently China’s current account surplus and willingness to achieve budget surpluses have been substantially reduced. In particular, the current account surplus-GDP ratio from about 9 percent in 2008 to drastically reduce the current level of only 2-3%. Third, we believe that the Chinese central bank’s views on the valuation of the yuan has changed in 2008 when the central bank that the yuan is undervalued, but since 2013 is considered a reasonable valuation. Therefore, we believe that the central bank’s trade-weighted exchange rate of RMB appreciation excessive tolerance will decline. Based on these factors, we believe that the current China’s central bank to make the possibility of devaluation is higher than in 2008.
The dollar’s recent ascent has therefore pulled RMB away from other currencies, leaving it increasingly overvalued: while RMB saw a 2.6% nominal depreciation against the dollar in 2014, it appreciated by 6% against a trade-weighted basket in the same year. Indeed, according to the Barclays behavioural equilibrium exchange rate model, the renminbi remains the second-most overvalued currency in the world, behind the Philippine peso but ahead of CHF and NZD.
If like myself, you have a very bullish target on the U.S. dollar index, the Chinese yuan is going to move into extreme overvaluation along with the greenback as the global carry trade (i.e. debt) unwinds.
More Chinese head abroad for CNY (Chinese New Year)
China’s outbound tourism boom is forecast to spike 20 per cent this year after hitting a record 109 million travellers last year. Many Chinese have been going on overseas holidays during the Chinese New Year as incomes rise, family bonds weaken and the importance of traditional festivals declines.
But this year, the trend has hit a fever pitch, buoyed by new factors such as an appreciating yuan against foreign currencies and relaxation of visa requirements by more countries for Chinese tourists. Tour agencies say they are seeing spikes of 30 per cent to as much as 300 per cent in tourist numbers to many regions, especially destinations in North-east Asia, Europe and the US.
And don’t forget the informational power of the offshore yuan: