MNI CHINA MONEY WEEK: Return Of The Offshore Yuan Basis Trade

--Offshore Yuan Discount Deepens As Tariffs Back On Agenda

     LONDON (MNI) - The swift about-turn in the U.S./China trade talks,

resulting in the imposition of 25% tariffs on around $200bn worth of Chinese

exports to the U.S (applied to goods leaving China from 0001 Eastern Time on

Friday), has pushed USD/CNH out of its recent trading range, with the pair

threatening to close above the 200-day moving average on a weekly basis.

     The discount (basis) that CNH -- the 'offshore yuan' -- trades at against

CNY has widened back to levels not seen consistently since February, with the

PBOC's daily fixing deviating from bank model projections on a couple of

occasions this week, to the benefit of the CNY.

     Potentially, this suggests the central bank is wary of a disorderly yuan

devaluation during the ongoing trade talks and will only use such a measure as a

last resort.

     This makes sense as it is a topic that U.S. President Donald Trump has

touched upon many times before. It also comes after Bloomberg reported that the

U.S. is set to "vet more trading partners for currency manipulation" in the U.S.

Treasury's semi-annual FX report -- which could result in deeper scrutiny of

those already being monitored.

     USD/CNH volatility has surged on the back of the trade talk dynamics with

1-Month and 3-Month at-the-money volatility hitting levels not seen since late

2018, albeit from a low starting base. Demand for USD/CNH calls drove the move

in vol, as USD/CNH 1-month risk reversals tested the 2018 highs, although the

3-month measure fell short of testing last year's peak.

     These moves were likely exacerbated by the fact that market held a

relatively relaxed view on the trade situation heading into last weekend, before

Trump caught markets off guard with a weekend tweet bring the subject of tariffs

back to centre stage.

     There has been much speculation as to what drove Trump to up the ante. Some

have suggested that the his constant pressuring of the Federal Reserve regarding

the loosening of monetary policy indicated a degree of weakness to the Chinese

side, driving President Xi Jinping to renege on previous commitments, although

Trump will likely view the recent pullback in Chinese stocks as an opportunity

to turn the screw.

     Increased yuan volatility should hold up, providing trade uncertainty

remains, especially given the aforementioned low starting base.

     The degree of uncertainty, at least in the short term, will largely be

based on the tone of the ongoing talks in Washington, which may itself be a

reflection of how "beautiful" the recent letter from Xi to Trump really was.

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

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