China’s FX shift won’t spark a sustained rally

IT WAS a decision that had been long awaited by the financial markets, analysts and policymakers alike. But the announcement by the Chinese central bank to gradually return the Chinese currency to a managed floating exchange rate was issued with little ceremony on Saturday evening Beijing-time.

Despite its vagueness, the statement was leapt upon yesterday by traders, who used it as an excuse to pile into riskier assets such as global equities, commodities and currencies such as the Australian dollar. Asian stocks rose across the board – the Nikkei 225 closed up 2.4 per cent and the Hang Seng rose 3.1 per cent.

European equities took their cue from the Asian markets and London-listed resource
stocks led the charge higher, tracking stronger commodity prices. In midday trade yesterday, all of the FTSE 100’s top 10 performers came from the mining sector. But should contracts for difference (CFD) traders view this latest frenzy of risk appetite as sustainable? Or is it simply a knee-jerk reaction, which will be quickly eradicated by a severe Budget in the UK and ongoing concerns about the European banking sector.

One strategist who falls firmly into the former, more optimistic, camp is Mike Lenhoff, chief equity strategist at Brewin Dolphin, an investment manager. “No point jumping the gun on this but we could be staring at the prospect of the ‘great global stimulus’,” he says.

His reasoning is two-fold. First, whatever the exchange rate adjustment, the competitive positions of the euro and sterling have improved already relative to the dollar-bloc currencies. Lenhoff believes that any appreciation in the renminbi from here will further enhance the respective competitive positions and gradually that of the dollar itself.

Second, “given the commitment by the Chinese authorities to sustaining their economy’s expansion, a greater degree of flexibility in the renminbi would be hugely positive for the global economy – and earnings,” adds Lenhoff. “The great global stimulus would work wonders for earnings momentum; it could easily turn that more recent downturn in the earnings revisions ratio around.”

Others, however, are less convinced that a yuan appreciation would have a sustained impact on risk appetite. Adam McCabe, portfolio manager of Aberdeen Asset Management’s Asian Fixed Income fund, says: “On balance it will be seen to be net positive for equities, commodities and risk generally as we recover from the European-based sell-off in May. But there is a risk that investors will overreact, since there is no guarantee that we will see a meaningful appreciation in the renminbi in the next three to six months.”

Joshua Raymond, market strategist at CFD provider City Index, says that while the shift in policy has given the markets a boost, the key will be if there is a bout of consolidation. “If people are willing to use any weakness as a buying opportunity then that would be a great vote of confidence,” he says, but adds that the rally seems to be more of a knee-jerk reaction.

Proof, as ever, that CFD traders should avoid jumping straight on the bandwagon.