Macro Digest: China signals support

Steen Jakobsen

Chief Economist & CIO

China is reintroducing countercyclical measures on CNY fixing, signalling support for the market.

Action: China is openly supporting a stable CNY and has thus 'committed' to intervention and support of its economy.

Reaction: This provides major support for Chinese stocks, which we believe are close to their low. The final test will be the new tariffs kicking in on September 6.

Trade recommendation: Buy China A-shares ETF (MCHI:xnas) at the New York open at around 61.30 with a stop-loss set at a closing price of 57.00 (see chart below). This is also confirmation of a potential top in USD strength as “floating dollars are increasing”.


It’s becoming more and more evident that the People's Bank of China and the yuan are key ingredients in emerging market valuations, as well as in the overall direction of USD. As with most things Chinese, the shift we see occurring is gradual but has a big potential marginal impact.

The shift, or the measure being undertaken by Beijing, is a commitment to keep the yuan stable. Through this stability, Chinese officials will create less outflow/downward pressure on CNY which will translate to less dollar buying overall. It’s part capital control, part economic confidence, but most importantly it represents China’s willingness to once again “support” the market and its economy.

This is of course good for Chinese shares and EM as a whole.

In its August 24 statement, the China Foreign Exchange Trade System cited the strengthening dollar and ongoing trade friction as the main reasons investors have kept bidding down the yuan. The reapplication of the “counter-cyclical factor,” it stated, could help the yuan remain largely stable (Wall Street Journal, paywall).

In an article published in the Financial Times (paywall) that same day, Tolani Senior Professor of Trade Policy at Cornell University Eswar Prasad called Beijing's move "an attempt to stave off two risks related to rapid currency depreciation: speculative capital outflows and rising trade tensions with Washington".

The yuan counter-cyclical formula has boosted Chinese shares in the past; according to Bloomberg, "USDCNY slid from 6.9 to 6.5 in the seven months after the PBoC introduced its new yuan fixing rule in May 2017 to stem market volatility. Consumer stocks led the CSI 300 Index of China's largest companies in a strong rally over that period."

Enlarge
Source: Bloomberg
More importantly, remember that the future direction of the dollar is driven by the net change of future expected growth between the US and China, i.e. the change in US growth over the next six-12 months minus the change in Chinese growth over the same period.

For the past few weeks, we have been focusing on this cyclical change wherein we expect a peak to have been established in the US economy with the Chinese economy accelerating as monetary policy and infrastructure spending are increased to counter an overly tight deleveraging process.

This will mean a stable CNY and a weaker USD in our opinion, which supports our belief that China is close to its low (with the ultimate test being the $200 billion in new tariffs set to come into effect on September 6).
Enlarge
Delta change of China Citigroup Surprise Index minus the US' change (source: Bloomberg)
The counter-cyclical measures is “secret”; we know the input but not the weighting of the different components.

Mid-point rate = Closing rate + change in currency basket + discretionary change (for more on this, see Natixis' excellent piece from August 18, 2017: China’s exchange rate policy: Adding a “countercyclical factor” to gain control).
Enlarge
Source: Natixis

This is the ETF mentioned above: the iShares MSCI China ETF. The weekly chart comes courtesy of my Saxo colleague, technical analyst Kim Cramer Larsson.

Larsson warns that a violation of support here could set up further weakness in the ETF, hence we are operating with the recent low being intact on any selloff.

Enlarge
Source: Saxo Bank

You can access both of our platforms from a single Saxo account.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)