A flexible Chinese Yuan (CNY) may create romm for other emerging market currencies to appreciate and thereby push up consumption of commodities in those economies in the coming months. This will prove positive for energy, gold and metals, according to an analysis by Bank of America-Merrill Lynch (BofAML).
Therefore, BofAML has maintained $78/bbl for WTI and brent curde for second half of 2010 and $85 for 2011. BofAML also expects crude oil prices to break $100/bbl next year.
The analysis of CNY appreciation in 2005-08 shows that Chinese exports will likely grow more slowly on account of appreciation. Following the three years post the revaluation, Chinese exports grew more slowly at 26% pa and so did oil demand (6% pa), relative to the three years prior to the revaluation (34% and 11% pa, respectively).
The near term prospects for gold are negative but BofAML maintains its $1500 target for the yellow metal on account of growing sovereign risk in Europe and further emerging market forex stock rotation into gold.and BofAML have just increased our average gold price forecasts to $1,200/oz and $1,350/oz in 2010and 2011, respectively.
Moreover, a gradual appreciation of the CNY and other EM currencies could exacerbate capital inflows into EMs, supporting gold accumulation over the coming months and dampening the effects of declining trade imbalances.
BofAML economists are of the view that a more flexible currency will allow China to gradually rebalance its economy, control asset bubbles such as the rally in property prices and reduce the threat of protectionism from abroad.
BofAML said that the People's Bank of China announcement on CNY flexibility will not lead to immediate change in USD-CNY exchange rate as the drop in the EUR-CNY has already resulted in a much stronger trade-weighted CNY in the recent period and China's current account surplus has started to close.
At any rate, a more flexible CNY is a positive development for the world economy because it signals a step forward towards global rebalancing, strengthening domestic demand relative to exports as a source of growth in China.
The impact of CNY revaluation will be positive for Chinese oil and global commodity demand. In the short-run, the net effect of a currency revaluation could well be a surge in commodity imports, as the purchasing power of China's consumers is enhanced through a stronger currency
By the same token, an appreciation of the CNY will make metals imports cheaper, likely allowing China to consume more foreign-sourced base metals and bulk commodities. As the Chinese economy rebalances away from exports towards domestic demand-consumption and investment-the CNY revaluation could be a net positive for growth and cyclical assets.
BofAML analysis points out that CNY revaluation will be a net positive for cyclical commodities like coal, zinc or copper. Thus, after the recent slowdown, we expect Chinese zinc import growth to resume over the coming months. Similarly, copper imports into China will likely remain firm on the back of the change in FX policy .Agricultural commodities will be less sensitive to CNY revaluation than metals.
Clearly, a higher CNY exchange rate will help boost the purchasing power of the Chinese consumer, effectively increasing real personal income growth, at a time that wage inflation is also on an upswing. Income and wages are likely to rise particularly for the lower-income groups, as underscored by a series of recent strikes and walkout at large industrial suppliers. This is particularly important because consumption growth in this income bracket is particularly intensive in raw materials.
China's rapidly aging population and shrinking young labour force are suddenly boosting the bargaining power of workers who are complaining about adverse work conditions and rising food prices. Higher wages and a higher CNY will increase real income growth and hence support durable goods consumption and oil demand for transportation. In particular, oil demand would skyrocket if Chinese consumers were to follow the path of South Korea in terms of oil demand per capita, BofAML analysis added.
Over the medium-term, a revaluation of the semi-managed peg will be an attempt to slow down excessive export growth and reserve accumulation. Over the course of the last year, very strong liquidity growth helped support high levels of oil imports. Lower export growth would typically feed negatively into economic growth, potentially creating negative feedback loops to oil demand growth. Historically, Chinese oil demand has been largely correlated with export growth.
Thus, while the short-term impact of a CNY revaluation on oil demand is likely positive due to an expansion in domestic consumption, it could reduce the pace of export growth. In our view, the 2% appreciation of the CNY in 2Q05 is somewhat illustrative of what we are likely to see in the future, BofAML analysis said.