Time To Watch China’s Currency Closely

October 8, 5:00 pm EST

China was on holiday last week (Golden Week).  So today, with China back to work, we saw the response in Chinese markets, for the first time, to the spike in global bond yields (and the slide in global stocks).

Chinese stocks fell by 3.7%.  The yuan slid back to the 21-month lows.  And the PBOC stepped in with the fourth cut of the year to its reserve ratio.

Now, China has been running sub-7% growth since late 2015.  And in China, that’s recession like economic activity.  The Chinese government’s sensitivity to this level of growth is clear through the behavior of the central bank’s use of RRR cuts and the currency (the yuan).   Cutting the required reserves for banks is a way to stimulate the economy – to promote lending.  Weakening the currency is a way to stimulate exports.

You can see in the chart below, that has been the path for both (the currency and the RRR) since late 2015.

You can also see in the chart, a period where the yuan strengthened sharply.  What gives?

That was China’s response to the Trump election.  The Chinese ran the currency back UP, in hopes of pacifying Trump and staying above the trade dispute fray.  It didn’t work.  As we know, they have found themselves at the center of Trump’s trade offensive.  As such, they have dug in, and returned to weakening the yuan — the best way they know, to defend/drive growth in their economy (i.e. undercut the world on price).  The USD/CNY rate here will probably become the most important market to watch in the coming days and weeks.  A return to 7 yuan per dollar would be the weakest level of the Chinese currency since 2008, pre-Lehman.  That will cause some geopolitical fireworks.

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