MNI ANALYSIS: China's Yuan Trending Weaker With Further To Run

--Positive Trade War News Could See Snap Back, M-T Weakness Likely

By Stuart Allsopp

     SINGAPORE (MNI) - Amongst the daily trade war headlines, USDCNH is trending

higher with little technical or fundamental resistance preventing further gains

for the dollar. Narrowing interest rate differentials versus the U.S., a rapidly

deteriorating external picture, and an expensive real effective exchange rate

all suggest that the yuan faces further downside, even if positive news on

U.S.-China trade relations creates a near-term bounce.

     --USDCNH BREAKING RESISTANCE

     MNI first highlighted the potential for the yuan to trade into a weaker

trading range back on June 8 and further highlighted the growing risks on June

13 in 'China's External Accounts Increasingly Yuan Negative'(for full story see

Mainwire at 0657 GMT). Since then USDCNH has broken through all meaningful

levels of resistance, including its 200DMA, amid a further collapse in interest

rate swaps spreads between the two countries.

     --RATE DIFFERENTIALS AT '09 LOWS

     Two-year swap spreads hit a new low Friday of 30bps (3.12% for the U.S. and

2.82% for China), down 190bps over the past year to the narrowest differential

since 2009. While part of this decline reflects higher U.S. inflation rates,

real yields have also moved markedly in the U.S.'s favour. China's banking

sector stresses should keep the PBOC on the back foot with regard to both its

deleveraging campaign and the potential for tighter monetary policy.

--STRONG REER NOT JUSTIFIED

     With real rates no longer supportive, its strong real effective exchange

rate, which remains near all-time highs, is no longer justified. As the recent

collapse in the country's trade surplus suggests, with its current account

looking increasingly likely to move into sustained negative territory, the

strong REER is taking its toll on China's competitiveness. Despite having the

world's largest foreign reserve assets, in contrast to the U.S., China's net

income account is already negative and looks set to deteriorate further acting

as a drag on the yuan.

     Exacerbating pressure on China's external accounts are U.S. demands to

increase imports to narrow the bilateral trade imbalance, which is prompting

fears that the PBOC may look to pre-emptively weaken its currency in order to

maintain export competitiveness.

--SHORT-TERM UPSIDE RISK TRADE WAR HEDS

     On a positive note, in an exclusive interview on June 21, a source told MNI

that Chinese trade officials have quietly approached their U.S. counterparts

seeking ways to minimize punitive tariffs on Chinese exports and avoid a

full-blown trade war. Other trade advisors and researchers for the Chinese

government told MNI that both China and the U.S. expect a mutual agreement to

end the trade row over the coming months.

     Given the widespread fear over a U.S.-China trade war, any positive

developments could cause some knee-jerk yuan buying. However, the yuan's

headwinds are myriad and are unlikely to be reversed by any improvement in trade

relations between Washington and Beijing.

--MNI Singapore Bureau; +65 8233 2326; email: Asia-Editor@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

[TOPICS: M$A$$$,M$Q$$$,M$$FI$,MN$FI$,MN$FX$]