Trading Signals 05/02 – 09/02
Chinese Yuan. Currency Overview
The Arrival of the Yuan
China was among the earliest nations to introduce monetary symbols. As far back as the 7th century BCE, they began utilizing coins, and by the 8th century CE, they had introduced paper money. Throughout the centuries, a diverse range of currencies were employed in various provinces. It wasn’t until 1948 that an official, unified currency was established with the establishment of the People’s Bank of China. This institution issued what became known as “people’s money,” with a gold content of 0.22217 grams of pure gold per unit, known as the yuan. In 1949, the currency was officially named “zhēnmínbì.”
It’s important to differentiate between the terms “zhēnmínbì” and “yuán.” While “zhēnmínbì” refers to China’s national currency, “yuán” is its unit of account.
The singular Chinese currency is represented by more than one ticker symbol — you may come across the designations CNY and CNH.
Difference Between CNY and CNH
The unified currency, zhēnmínbì (yuan), involves two rates: onshore (CNY) and offshore (CNH) yuan. Onshore yuan is used exclusively within mainland China. It’s regulated— the exchange rate of CNY is controlled by the People’s Bank of China, and transactions within the mainland are allowed within a 2% range of the base rate.
Offshore yuan, CNH, is utilized in foreign markets and is regulated by the Hong Kong Monetary Authority. Its value is determined by trading volume. Frequently, Chinese authorities adjust the USD to CNY exchange rate by purchasing CNH on the Hong Kong Exchange.
The exchange rate of offshore yuan can differ from that of onshore yuan. It’s more volatile since it’s influenced by a greater variety of market factors.
Challenges Impacting China’s Currency
The devaluation of the yuan is a result of the complex state of China’s economy. Although the country’s GDP is indicating growth this year and is projected to increase by approximately 5% in real terms by year-end, these figures align with the government’s objectives. However, it’s important to note that GDP is a statistical metric that might not comprehensively capture the entirety of the nation’s economic trends.
Gross Domestic Product (GDP) represents the total monetary value of all final goods and services produced and sold within a country during a specified timeframe.
Following the lifting of lockdowns, China’s economy has confronted a range of challenges, most of which exhibit structural attributes rather than being tied to cyclical patterns.
There hasn’t been a notable upswing in internal consumption. Retail sales during the June Dragon Boat Festival fell short of the levels seen prior to the pandemic in 2019.
The country’s population has experienced a decline. By the close of 2022, China’s population had diminished, and according to estimations from the UN, this marks the initiation of a long-term trend.
Youth unemployment is presenting a substantial issue. Unemployment rates among the younger demographic (ages 16-24) have reached unprecedented heights, surpassing 20%.
A decrease in imports has been observed. The metrics associated with foreign trade have demonstrated an eight-month contraction: year-on-year imports have been shrinking since the prior October, a reflection of weakened domestic demand within China.
A dip in exports has also been evident. Exports have been on a downward trajectory since the aforementioned October period, with the exception of a one-time surge in March-April attributed to the fulfillment of accumulated orders resulting from quarantines and holidays. The decline in exports in June amounted to a 12.4% drop when compared to the previous year’s figures, while import decline registered a 6.8% decrease from the prior year. The Nikkei reported that China no longer holds the distinction of being the largest exporter to the US as of June.
The real estate domain has also remained problematic: both sales volume and property prices have been in decline until mid-2023, and certain developers experienced renewed instances of default during the first half of the same year.
The composition of China’s economy and the pace at which its GDP grows also signify important aspects. Internal consumption constitutes approximately 38% of the GDP, a comparatively modest proportion when contrasted with more advanced nations. For instance, in the United States, this figure surpasses 66%. Consequently, the domestic market within China’s export-driven economy could be characterized as underdeveloped and presently unable to sustain the requisite economic expansion. Notably, investments command the largest segment of China’s GDP, accounting for about 43%, with infrastructure investments notably contributing to the GDP growth trajectory.
As experts evaluate the landscape, investments have historically underpinned around a third of China’s GDP growth. However, these investments have been facilitated by a considerable upswing in China’s debt load: over a span of ten years, the country’s debt-to-GDP ratio escalated from roughly 30% to nearly 80%. This year’s fiscal deficit, projected to hover around 7% concerning the consolidated budget, implies that the trajectory of growing debt is poised to continue.
What the Future Holds for China’s Economy and the Yuan
The Chinese government is fully aware of these challenges: statements have been made since March about supporting economic recovery and boosting domestic consumption, along with the implementation of fresh stimulus measures. However, the extent of fiscal support has been constrained due to the government’s existing debt load. The effectiveness of monetary policy easing also raises queries: liquidity in China’s financial system remains stable, with the money supply growing by 11% compared to the previous year. Nevertheless, the People’s Bank of China (PBOC) has initiated another round of rate cuts, reducing rates by 10 basis points in June.
The PBOC’s rate reductions, set against the backdrop of the still-increasing rates set by the US Federal Reserve, have led to a widening gap between interest rates on yuan-denominated bonds and US dollar bonds. Typically, this has a negative impact on currency valuations, resulting in lower rates. In response, the yuan experienced a decline against the dollar in June. Interestingly, interest rates in China are now lower than those in the US. Following the bursting of real estate bubbles in developed nations like the USA, Japan, and the EU, these countries “treated” their economies by maintaining rates at minimal levels. A similar trajectory might be in store for China.
The Chinese regulatory authority holds the capability to further decrease interest rates, considering the economy’s proximity to a deflationary state, as evidenced by the absence of annual consumer inflation growth. Investors often perceive a currency from a nation with lower inflation as more stable, associating inflation with currency devaluation.
Nevertheless, inflation levels carry different connotations for influential traders and economists. In China, low inflation is interpreted as an indicator of subdued domestic demand, reflecting economic vulnerability and resulting in the depreciation of the yuan. This might appear counterintuitive, but an uptick in China’s inflation levels would be favorably regarded within the currency market in relation to the yuan.
Likewise, in the United States, the observed decline in inflation levels has manifested in the weakening of the dollar against global currencies. A decrease in inflation implies a diminished likelihood of the Federal Reserve increasing or maintaining high interest rates over an extended period. Consequently, yields on dollar-denominated bonds also diminish, contributing to the dollar’s devaluation against other currencies.
How Investors Can Take Advantage of the Situation
In a broader context, the Chinese yuan offers an attractive opportunity for holding currency reserves when compared to the dollar at its present levels. The USD/CNY exchange rate is presently situated at lows not seen in years, and the People’s Bank of China (PBOC) is indicating its commitment to sustaining the yuan. Moreover, as the US Federal Reserve (Fed) initiates a gradual relaxation of its monetary policy, a measured weakening of the dollar is foreseeable.
Additionally, the yuan has the inherent potential to strengthen as China’s economic landscape improves. However, realizing this potential would require additional support measures from the government, and conceivably, even structural economic reforms.
Investors have the potential to reap benefits from this scenario by diversifying their currency portfolio to encompass the yuan. The current propitious conditions, coupled with the yuan’s potential for appreciation driven by market dynamics and government backing, make it a pragmatic avenue for those aiming to manage currency-related risks and seize possible gains. As with any investment strategy, meticulous research, consultation with financial professionals, and a comprehensive comprehension of market dynamics are crucial before making any investment decisions.