Goldman: Pressure Building For USD/CNY Upside

Goldman Sachs note that “significant pressure remains for EM currencies: in recent days we continue to field questions about macroeconomic indications of EM FX vulnerability and the potential for further EM FX weakness. Set against this challenging backdrop, the USD/CNY cross has been anomalous: USD/CNY has been managed in a range between 6.60 and 6.80 since mid-May, despite strength in the broad USD and currency selloffs among China’s trading partners and the Yuan’s EM FX peers. The relative stability of the Yuan is particularly striking given that investor concerns around both (i) the growth impacts of China’s strict public health policies as Covid cases continue to rise, and (ii) renewed fears around China’s property sector. Overall, these challenges to China’s growth outlook remain unresolved, and our economists think that the strong economic recovery in China that we saw in June may not be sustainable in H2. For FX investors, this has begun to feel familiar: in the first few months of 2022, pressure built on a tightly managed USD/CNY exchange rate as the Yuan saw sustained appreciation versus TWI and CFETS baskets. Ultimately, this pressure was relieved with a nearly 7% move higher in the USD/CNY cross. However, more CNY appreciation versus TWI and CFETS baskets means that pressure for USD/CNY upside is building again.”

• “CNY stability appears anomalous relative to renewed weakness in Chinese equities and a turn down again in the China-US rate differential There are some macroeconomic tailwinds for the Yuan, including a very strong trade surplus that could help support the CNY over the medium-run. In our view, however, risks of another bout of USD/CNY upside have risen over more tactical horizons: while the Yuan has so far avoided the June and July selloffs of its regional and EM FX peers, two areas of concern have appeared in Chinese assets. First, some pro-cyclical parts of the Chinese asset complex, led by A- and H-share equities, have begun to reflect deteriorating domestic growth expectations: Chinese equities have stumbled since July 5th, even as a number of EM equities seen gains in local currency terms. Second, renewed concerns around Chinese growth also appear to be feeding into both absolute moves lower in Chinese rates, and a continued fall in front-end China-U.S. rate differentials. In brief: while USD/CNY has held firm, other parts of the Chinese asset complex appear to signal increasing risks to USD/CNY.”