DIRECTOR OF CURRENCY RESEARCH, GFT
LAST weekend Chinese monetary authorities announced that they were ending the yuan peg to the dollar that was adopted during the credit crisis to protect the country’s exporters. The People’s Bank of China (PBoC) noted: “In a continuation of the foreign exchange reforms launched in 2005, the yuan will not undergo a one-off revaluation, serving market supply and demand will continue to act as a base, and adjustments will be made with reference to a basket of currencies. The trading band will be maintained according to its existing parameters, the floating exchange rate will be subject to dynamic management and adjustment, the yuan will be kept basically stable at a reasonable and balanced level.”
As a result of the announcement, dollar-yuan fell below the key 6.8000 mark – its strongest level in more than two years. The move by the PBoC was not only a sign of confidence in the sustainability of the global economic recovery but it was also a response to the rising inflation pressures and the growing housing bubble within the Chinese economy.
The FX markets greeted the move enthusiastically. Commodity dollars attracted most of the buying on the assumption that China will increase purchases of raw materials as the yuan gets stronger. I already like the Australian dollar and the Canadian dollar on a relative basis since they have better balance sheets than the G3 economies and their central banks are already tightening monetary policy. If the yuan does appreciate, both the Aussie and the loonie should continue to do well against the euro and the pound.
Still, the pace of appreciation is likely to be slow. Several analysts have predicted that dollar-Chinese yuan could reach 6.5000 by year-end, but such a move would have to occur against a background of sustained economic growth of 3 per cent or better. The latest data from across the G3 has shown a slowdown in consumer demand that could temper those estimates in the second half of this year. If that were the case, then the appreciation of the yuan could be much less dramatic than the market imagines and the rally in risk FX would wither as result.
Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail firstname.lastname@example.org.