CNY Float To Cause Midsummer Madness?

By: Kevin Sollitt

Last week’s column argued in favour of cable making a near-term base (Sterling downside may be overdone).
While early signs have been significantly supportive of such a theory with the rate rising from 1.4550 to a high so far of 1.4938 over the past week, caution is warranted ahead of this week’s UK emergency budget that is expected to contain some controversial & perhaps drastic measures that could undermine short term bullish sentiment. For those with open exposure we recommend raising the stoploss to at least entry level, leaving scope to reestablish the strategy if the market receives the budget positively.

Meantime, the initially big but now somewhat diluted news is that China announced resumption of the Yuan’s flexible arrangement by abandoning the outright peg to the USD.
If the market was not in such a funk, or generally clouded demeanour, we would have expected a marked continuance of the initial USD softness caused by the announcement. After almost 24 hours, the USD is little changed against majors from Friday’s closing levels and is in fact higher against the JPY.

There are at least two initial schools of thought on the FX implications for this move, CNY aside:
One is that exporters to China in particular will see a demand-led advance in their home currencies, with particular emphasis on AUD, CAD & BRL. Although Yen should also benefit from the same argument, we should remember that JPY stood at around 120 versus its current 91 the last time China made such a move, so not only has much of the work against the USD already been done by the market but the fact that US debt will now most likely continue to be recycled in China by absorption of treasury issuance, the pursuit of yield by Japanese life insurers may actually see USD/JPY remain range-bound but with a USD-bid bias.
Second is that this move removes the need for a more significant reval in the future and despite an abandonment of the $ peg may yet cause legislation to be examined or introduced by US senators regarding trade protection measures.

The first point is pro-risk, the second not so. Further delay to economic stimulus in the US may have wider ranging repercussions than are currently assumed.
Continuing on the path of risk-awareness, we note that most surprise moves in the market lately have been to the downside, evidencing risk aversion. While the move by Chinese officials is a welcome beginning to the task of global rebalancing, it is not a quick fix or instant panacea designed to ease the woes that have been causing such consternation in FX over the past few months.

Markets are showing little patience with official rhetoric of late, for example EUR/CHF plummeting from the mid 1.40s to 1.3725 despite the SNB saying they will defend rapid appreciation of the CHF.

Our concern is that something similar may emerge from the confusion generated by China’s announcement which is seemingly well-intentioned but may lead to the market making up its own mind that such a move is not enough and may continue to temper global economic growth, as European trade with China more or less dries up due to lower buying power & economic fragility.

If this is true collective attention will likely return to the gridlocked state of play and cause a refocus on the probability that the next big move could be a decline in the so-called ‘risk’ currencies, counter to current expectations.

While this scenario is far from guaranteed, other factors exist that may conspire to sour the mood of the markets; near double-digit unemployment remains stubbornly apparent in the US & in addition the as-yet unknown ramifications of the Gulf of Mexico oil spill may have a devastating environmental and economic effect as details become clearer over the summer.

For now, we are not buying EUR or USD against anything, instead focusing on crosses with better fundamentals and sentiment.

This week’s trade idea is to sell NZD against NOK, a commodity play on both sides to a point but we like the underlying oil and fiscal positions of Norway to outweigh pro-risk Kiwi sentiment: Sell NZD/NOK entering 50% of position at current market 4.54; add remaining 25% each at 4.58 and 4.62, stop-loss on a confirmed break above 4.68. Lower stop to breakeven as the market falls with an initial objective on half at 4.25-4.30.

Good luck trading.