MNI China Money Week: Market Saddles Up For Lengthy Yuan Ride

     BEIJING (MNI) - The yuan's rapid rise against the U.S. dollar this week has

Chinese traders increasingly believing the renminbi will have a strong close to

the year because the dollar index is likely to remain weak due to continued

uncertainties about U.S. policy and the rallying euro.

     The yuan last traded at 6.5839 against the dollar at 2pm Beijing time on

Friday, rising 1.21% so far this week, the biggest weekly rise on record,

according to data going back to July 21, 2005. The yuan appreciated 1.96% in

August against the green back, the biggest monthly rise since July 2015 when it

rose 2.07%.  

     One reason for the enthusiasm for the yuan this week are higher dollar

depreciation expectations after both U.S. Federal Reserve Chairwoman Janet

Yellen and European Central Bank President Mario Draghi avoided any mention of

future monetary policy in their speeches at the Jackson Hole conference last

week. This raised the prospect that Fed and ECB policy would not be tightened as

much or as rapidly as traders had expected previously. 

     "Yellen and Draghi both did not offer more details on the prospect of

monetary policies in Jackson Hole," Huang Wentao, Li Yishuang and Guo Chang,

analysts at China Securities, said on Tuesday. "But as the presentations

alleviated market worries about Draghi thinking that the euro has become too

strong and Yellen believing the financial environment is too loose, the rebound

of the dollar has not yet become a reality."

     The dollar index remained low this week, closing at 92.6243 on Thursday, up

slightly from 92.5451 last Friday. But its drop of 0.2% in August added to the

2.95% plump in July. 

     The yuan's relatively-uninterrupted rise in the past four months has

created momentum that accelerated its rapid gain this week, as traders clambered

on board. 

     "The rapid rise [of the yuan] this morning was basically caused by traders

and investors buying back yuan, as they noticed that the yuan has remained

strong," a Shanghai-based foreign-exchange trader at a commercial bank told MNI

on Wednesday. "Some investors bought the dollar yesterday as they bet it would

rebound."

     Hastily placed stop-loss orders by yuan sellers underscored the growing

consensus that the yuan is more likely to strengthen than decline. 

     "If we take a look at the yuan fixing price recently, we can observe the

fall of the dollar index certainly leads to a rise in the yuan fixing price,"

Han Huishi, an analyst at China Construction Bank, said in a report published

Wednesday. "So if traders who sell yuan notice the dollar index getting weaker

during intraday trading and if there is no news that would likely push the

dollar index higher overnight, the pressure on them can be tremendous, as the

yuan will certainly go up the next day."

     "As long as traders who go long on the dollar don't have a good sense when

the dollar will rebound, the safest strategy is to sell the dollars they hold,"

Han continued.

     The People's Bank of China set the yuan central parity rate against the

U.S. dollar at 6.5909 Friday, stronger than Thursday's 6.6010. The PBOC has set

the fixing stronger for all five trading days this week, an appreciation in the

parity of 1.01% for the week, the largest weekly rise since the first week of

January this year, when it also rose 1.01%. 

     Rising yuan appreciation expectations have caused both investors and

companies to postpone their plans to buy dollars.

     "In the past, especially from 2014 to 2016, when the dollar rose the yuan

would fall, but when the dollar fell, the yuan did not rise. But for now, when

the dollar falls, the yuan will rise," Han said. "The pessimistic expectations

on the yuan have faded, and domestic investors are waiting for the yuan to

appreciate further as they expect the dollar will remain weak."

     How the dollar index moves will directly determine how the yuan moves. And

the outlook for the index is heavily affected by the trend of the euro, which

accounts for 57.6% of the weighting in the index.

     The euro has remained strong against the dollar this year, thanks to the

rapid strengthening of the eurozone economy.

     "The growth of the U.S. economy is reaching its limit, while the revival of

the eurozone is still in its first half," Wu Jieyun and Liang Hong, analyst and

chief economist at China International Capital Corporation (CICC), said in a

report last week. "So from the perspective of growth expectations, the eurozone

is better than the U.S.," which will create pressure for the euro to appreciate

against the dollar.

     Monetary policy is seen as another reason the euro is maintaining its

strong pace.

     "Typically, the tighter monetary policy is, the more likely the currency

will appreciate," Wu and Liang said. "The market has not fully priced in the

potential quantitative easing tantrum in Europe, but the market has fully priced

in the balance sheet contraction and rate hike of the Fed. So if the European

Central Bank decides to tighten monetary policy, the euro will likely get

stronger."

     The European Central Bank's next meeting on Sept. 7 will be closely watched

for clues about when the central bank might start to taper off its quantitative

easing policy. At his press conference after the ECB board meeting, Draghi is

expected to offer more details on the outlook for monetary policy and his

thoughts on the strong euro, which could have a big influence on the euro and

the dollar, and so the yuan.

     Dollar sentiment was also hurt this week by North Korea's launch of an

intermediate-range missile over the Japanese island of Hokkaido on Tuesday.

Investors fear that North Korea-U.S. tensions will continue to rise, which would

further dampen the dollar index.

     So far, the People's Bank of China has shown no intention to prevent the

yuan from rising further, despite the fact that a stronger yuan could crimp

Chinese exporters. The introduction by the PBOC in May of a "counter-cyclical

factor" in its calculation of the daily fixing gives the central bank more

leeway to influence the yuan exchange rate if it chooses to do so. 

     "The [yuan] fixing price that the PBOC set today did not show the PBOC

intends to slow the yuan rise, as the counter-cyclical factor did not have any

effect today," the Shanghai-based trader said on Wednesday. "So I think the PBOC

is fine with the current level of the yuan."

     Sheng Songcheng, an advisor to the PBOC, said last week in an interview

that he believed it is "totally possible" for the yuan to end the year in the

range of 6.5 to 6.6 versus the dollar, given China's current strong economic

fundamentals. 

     Traders generally agree with Sheng. Another forex trader at a Shanghai

commercial bank said the yuan would "certainly" be below 6.6 against the dollar

by the end of the year, and that reaching 6.5 is also "very possible."

     But the rapid strengthening of the yuan just a few months removed from

strong depreciation expectations has also made traders more cautious about

projecting when the rising trend will end, shows as it does how currency

sentiment can reverse quickly.

     "I do not want to guess whether the recent strengthening trend of the yuan

has ended or not because I will lose a lot if I am wrong again," said a third

Shanghai-based trader at a commercial bank, who had previously forecast that the

yuan would not rise too rapidly. "Anything is possible right now."

     Analysts said the weak dollar will only have a chance to rebound if the

U.S. economy outperforms expectations.

     "Whether the dollar index will rebound will rely heavily on the improved

performance of [U.S.] economic conditions and inflation," Huang, Li and Guo

said. "That would lead the market to re-price the possibilities and times of

[Federal Reserve] interest rates hikes and balance-sheet contractions."

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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