China struggles to support CNY & avoid exporting disinflation

<p>The People’s Bank of China is increasingly resisting traders’ weakening of the Chinese yuan, by announcing higher rate in its daily central reference rate. But […]</p>

The People’s Bank of China is increasingly resisting traders’ weakening of the Chinese yuan, by announcing higher rate in its daily central reference rate. But as Chinese data continue to weaken across the board, FX traders have no choice but to bet against the yuan (pushing up the USD/CNY rate).

The chart highlights the divergence between the PBOC’s falling reference rate, known as CNY fixing price as set by the China Foreign Exchange Trading System (red) and the spot rate in the interbank market, the fluctuations of which should not exceed +/- 2% of the average price.

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Aside from signs of China’s slowdown shown in retail sales and consumer credit, last night’s release of Nov PPI contracting by 2.7% — below zero for the 13th consecutive months — and the 1.4% CPI being the lowest in five years underscores the threat that China’s hard landing story is at its most credible status since misplaced warnings have begun in 2009.

The adjacent chart highlights China’s deteriorating capital account balance, which tumbled to a negative $601 million in Q2 as a result of surging capital outflows. We patiently await the release of capital account breakdown for Q3.

Deflation: Made in China

With much focus placed on central bank policies, and OPEC decision and the price of commodities all pointing in the direction of disinflation, China’s weakening currency will be the next “major theme” to watch. USD has gained less than 1% against CNY so far this month. But if the yuan descends into a fall of more than 10% (it’s down 1.6% since October highs), brought about by signs of a hard Chinese landing, then the commodities story will break into deflationary spiral, exacerbated by China’s exporting of disinflation.

CNY vs Ref Chart Dec 10

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