MorningWord 8/12/16: Yuan a Fight?

by Dan August 12, 2016 9:53 am • FREE ACCESS

A year ago yesterday, the People’s Bank of China (PBOC) devalued their currency in dramatic fashion in reaction to deteriorating export data. The unexpected policy move was a spark that lit the global risk asset bonfire in the weeks to come:

Snip20160812_2

The PBOC referred to the move as a one time adjustment. But a year on, it’s clear that this was a policy shift, not a one time action. The Yuan is a good deal lower than August 11th, 2015:

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The Chinese are in the midst of dramatic economic reforms, while also attempting a soft landing for their economy, whose GDP growth has been cut in half from 2010. Overnight, China saw a Trifecta of bad data for their economy in July. From Business Insider:Snip20160812_4

Obviously this is just one months data. For the most part, Chinese stocks don’t seem too bothered with the volatile economic data. The CSI 300 (the Shanghai Shenzen A Share Index) is still down about 12% on the year, and 38% from its 2015 highs, but it is now rebounding to levels it has not seen since early January:

CSI 300 since Jann 2015 from Bloomberg
CSI 300 since Jann 2015 from Bloomberg

And why not? The weaker Yuan should be a boon for Chinese exporters.  But as The Dude famously said in the late 90s, “This is a very complicated case…. You know, a lotta ins, lotta outs, lotta what-have-yous”.

When I look at the data, the direction of the currency, the chances the PBOC’s surprises on policy action, the relative calm in Chinese stock markets as they’re bouncing along the bottom of 5 year lows, and I see trading opportunities.

And that takes me to the FXI, the etf that tracks the FTSE China 50 Index. It is made up of large cap H Shares (Hong Kong listed, primarily tech, banks and oil).  The FXI recently broke out to new 2016 highs, with little overhead resistance for another 10% to about $40.  From a purely technical standpoint, it’s in a very healthy uptrend:

FXI 1yr chart from Bloomberg
FXI 1yr chart from Bloomberg

I’ll just say this, no matter what your directional inclination is options prices are fairly cheap, nearing 52 week lows, making defined risk strategies in the FXI relatively attractive into what could be an increasingly volatile time for the Chinese economy:

FXI 30 day at the money implied volatility since Jan 2015 from Bloomberg
FXI 30 day at the money implied volatility since Jan 2015 from Bloomberg

You can’t talk about China’s economy without mentioning the role of geopolitics. A year after China’s currency action, it seems like Republican nominee for President is the only one focused on China, even if he gets most of the story wrong. And maybe the lower his poll numbers go, the lower the Yuan will go as it’s unlikely Clinton starts any sort of obvious trade/currency war. But Trump has made the trade imbalance with China a major part of his pitch to areas adversely affected by globalization and the loss of manufacturing jobs. And he has stated he would renegotiate “all the trade deals”. So if Trump’s numbers were to rise again, or if this topic saw more light during the debates, forcing likely winner Clinton to express a more hawkish view on the trade imbalance with China, I suspect the powers that be in Beijing would lay low and not make any sudden moves with the Yuan, for fear of stirring up an even bigger political hornets nest in the U.S.