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On April 14th China surprised the markets and announced that it would widen the daily trading band within which the yuan can move versus the US dollar, to 1% from 0.5% effective immediately. The last time it widened the daily trading band was by 0.2% to 0.5% back in 2007, so last week's move was a significant step by the Chinese authorities.

What does it mean?

 

The move has been welcomed as a sign of Beijing's commitment to capital market liberalisation. Although the authorities still control the movement in the yuan, this may be a precursor to a free-floating currency sometime in the future.

A free-floating currency would change the face of global capital markets and trade due to the size and opportunity of the Chinese economy, thus this news caused a wave of excitement when it was announced.

Why did China do this now?

 

The authorities gave no direct explanation, but the markets have settled on a couple of reasons why China acted last week:

  •  The Chinese authorities are confident that the economy won't have a hard landing and is thus willing to allow the currency a bit more freedom to move without negatively impacting China's large export sector. This should be risk positive.
  •  The widening of the trading band means that the yuan can move both up and down by 1% on any given day. This is helpful for the Chinese authorities since everyone seems to want a weak currency right now including Norway, New Zealand, Switzerland, Japan and some Eurozone members. The trouble is that not everyone can have one. If China allowed it's currency to free-float it could sky-rocket, so last week's move is actually very clever - it gives the Chinese authorities the remit to weaken the yuan if the external economic environment deteriorates substantially.

The race to the bottom in FX

 

The actions by the Chinese are part of a broader round of global intervention. As we mentioned above it seems like every central bank is talking down their currency right now, the Swiss National Bank has intervened to weaken the franc and implemented a floor in EURCHF at 1.20 and the Japanese authorities may pump another round of yen-weakening stimulus into its economy when it meets later this month. Intervention doesn't always mean a weaker currency. The Singapore Monetary Authority widened its trading band earlier this month which caused a sharp appreciation of the SGD versus the dollar (see Tech Talk below).

Market reaction:

 

The initial market reaction was muted. The move was announced on a Saturday when the markets were shut and Eurozone sovereign concerns were the focus in the financial press. The bigger effect will be felt in the long-term. Traditionally the Aussie, commodities and other Asian currencies are dominated by China. In the long-term the impact on the Aussie and commodities could be negative, especially if the yuan starts to appreciate at a faster pace thus boosting domestic demand and weakening the commodity-intensive export sector. However, it is difficult to quantify the exact timing or impact that Chinese currency policy could have on the Aussie since other factors also impact its value.

Over the past year the performance of USDCNY has had no significant impact on the direction of AUDUSD, and the pair has a 12-month correlation of just 8% and since the start of the year that has fallen even further.

Interestingly, AUDUSD has had a much stronger correlation with USDSGD. When USDSGD has appreciated, AUDUSD has depreciated 78% of the time since the start of the year. However, this could be due to broad dollar moves rather than a special relationship between the SGD and AUD. The performance of the Singapore dollar also has no correlation of note with the renminbi on both a long and short-term basis, although its correlation at 17% since the start of 2012 is stronger than that between USDCNY and USDHKD, which is a mere 4%.

The low correlations are to be expected in controlled currencies since the biggest relationships that the yuan, Singapore dollar and Hong Kong dollar have is with their central banks who ultimately control their movements.

The retail trader is most likely to find a trading opportunity if there are changes in policy like we have just had in China and Singapore. This can happen if the external environment shifts (a global economic downturn could cause controlled currencies to weaken, while a boom could see them loosen the controls). The problem is that it's incredibly difficult to predict with much accuracy when the Chinese authorities will change policy, the Singaporean authorities tend to announce it during policy meetings. Right now the best way to trade the Chinese economic landscape remains the Aussie dollar, which has remained resolutely lacklustre this year. AUDUSD remains stuck in a stubborn range between 1.0270 and 1.0420 as risk assets juggle Chinese growth fears with Eurozone sovereign concerns. However, if the currency move by Beijing was a result of greater optimism about the economic outlook then would be Aussie positive, but we need to see more Chinese economic data prints before we can say that with any accuracy.

Tech Talk with Chris Tevere: USDSGD

 

Key Technical Developments:

 

· 13-day sma remains below the 144 & 169-day ema's which have proven resistive (bearish)

· Broke below the bottom of daily Ichimoku Cloud around 1.2550/55 late last week

· Elliot wave analysis suggests it is in wave-v, of wave-c (blue) of wave-C (black) - Implies a test of 1.2385 at minimum

· Triangle support around 1.2530/40 gave way last week and proved resistive earlier today

· Daily RSI confirmed the triangle break lower

· Below current levels it sees the 61.8% retracement at 1.2450/55

· Trendline support around 1.2430/35, drawn from the October 2011 low

· The triangle break lower projects a measured move of 1.2240/60 - Which also sees the 78.6% retracement

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Chart Source: Forex Charts by eSignal

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

d: +44.(0).20.7429.7924 | f: +44.(0).20.7929.2010 | M: +44 (0) 7919.411.957 | e: kbrooks@forex.com| w: www.forex.com/uk

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