◆ 3 days of strongest yuan fixings YTD, CNY still > 7.2
◆ Why PBOC loosened its grip on CNY: the yen
◆ Japan-China trade (im)balance
◆ CFETS & BIS currency baskets show: 🇨🇳CNY is actually holding up, but 🇯🇵JPY is getting decimated
◆ Market implications: CNH / JPY & US yields
◆ Long JPY (even as USDJPY breaks new highs) outlook
I last published a note addressing the Chinese yuan and the Japanese yen's alarming and interdependent weakness vs USD respectively, posing a looming potential threat to near term market stability (currencies and rates). On Friday, China had fixed the yuan stronger than market estimates, but with less gusto relative to their recently aggressive CNY fixings above estimates, causing a sharp rally in USDCNY through the 7.2 level that PBOC had spent 2024 defending. And, as USDCNH and USDJPY have been moving in tandem so far this year, and with USDJPY right on the edge of breaking out to a new three-decade level high, a plunge in the yuan can push the yen off a cliff, which can then lead to broader global macro market volatility. Excerpt below:
Note that even if we don’t get the Oct’22 sustained reversal move repeat (USDJPY 152 → mid 130s, -1% taken out of 10Y UST yields within 2½ months), large JPY swings ↑↓ can see US Treasuries realized volatility to explode higher - which is not good for anyone - erratic, un-tradable markets and forced liquidation mayhem.
And again - this can all stem from sharp yuan weakness. If China has decided to let the yuan weaken (for whatever reason - but likely due to a decisive shift in PBOC easing measures) - that decision and corresponding (in)activity in yuan support can potentially cause global market knock-on impact.
https://westonnakamura.substack.com/p/yuans-rollercoaster-and-jpys-floor
That yuan leniency only lasted for a day, as so far this week, we are seeing PBOC rushing back to aggressively defending the yuan in their daily midpoint fixing well above market estimates.
•Monday: PBOC fixed CNY at 7.0996, more than +1,200 pips stronger than dealer estimates (strongest since November 2023), and reversed a good portion of the prior Friday session's sharp losses.
•Tuesday, PBOC comes in with another aggressively strong CNY fix at 7.0943, +0.07% vs Monday which was the most since January.
Wednesday: Yuan reference rate set at 7.0946 for the strongest fix vs estimates this year at +1,276 pips.
Yet, despite all of the continuing yuan defense after just a single day slide, USDCNY still remains above 7.20. Markets were (are) really shook by Friday’s shock move, and are trying to figure out where PBOC stands with their currency strategy.
Below is a chart from Bloomberg of (what I assume are standard 25-delta) 3 month risk reversal options prices on USDCNH. Don't worry about what that means or entails if you're not an options trader - chart just shows the price of a common hedging strategy for those who are directionally short
The reason I've pulled this chart is to show just how much that intraday move on USDCNH to end last week had surprised and alarmed markets. There is no comparable single-day move in the past year (and further back), despite moments of sharp USDCNH upside for this chart's recent unparalleled vertical move higher. Note the price range: USDCNH 3-month risk reversals made a single-day price jump from -0.20 (meaning you got credited/received 20bps to open this position) to 0.50 (now costs you 50bps to open this position). And although this options strategy has since fallen after PBOC re-stabilized yuan stronger, it’s still firmly out of getting paid to open territory.
So, what was last Friday’s slip all about?
I also said the following in my previous note on the reason why China suddenly let the yuan go unsupported relative to it's months’ long efforts of doing just the opposite:
For today / this AM session open in Asia, it seems China is trying to reverse Friday’s yuan plummet- but that doesn’t mean that their big picture desired direction is continued yuan strength/support.
Today’s ‘24 YTD strongest PBOC fixing may just be to mitigate a short term move that went too far too quick- but they did let yuan go on Friday, and without much in state banks’ PM session close buying support.
I don’t know why they did (yet), I just know that they clearly did - and that requires us to keep a very watchful eye on PBOC and China.
I may have figured out why PBOC set a significantly weaker fixing on Friday to allow for the yuan to weaken - only to reversed course upon Monday at market open. And it may not even be due to PBOC’s own surprise of just how sharp of a single day sell off it had invited.
Here is why PBOC let yuan weaken on Friday, and what everyone (including myself at the time) is missing.
It wasn't/isn't about the yuan’s exchange rate against USD- the dollar was not the currency that PBOC was focused and acting upon on Friday of last week (though USD is the cross rate that it is subsequently responding to so far this week).
Rather, PBOC was watching and acting upon JPY weakness.
CNH/JPY (CNY/JPY), the Chinese yuan / Japanese yen exchange rate, which has been rallying, even as the yuan has been weakening against USD.
Indeed, USDJPY is pushing right up against that three-decade high 152 break-out level, but not there just yet. And similarly, USDCNH still remains below its November 2022 levels of breaking out to new multi-decade levels:
And even upon the recent USDJPY surge which the March BOJ policy release had further fueled, USDJPY remains below that 152 danger zone. BUT - that JPY downside move upon March BOJ DID put into motion the subsequent sharp USDCNH upside move in the days that followed…
…as CNHJPY, the yuan/yen cross rate DID break above recent highs, November 2022 highs, and June 2015 pre-yuan-shock-deval highs.
In other words, CNHJPY broke through all time highs following March BOJ - even as the yuan/dollar rate drops and closes in on breaking new decade lows (USDCNH highs).
So - the USD strength was not the cross rate/issue that PBOC was concerned with in the back half of last week - JPY weakness (or yuan “strength” against JPY) was - as CNHJPY broke through and printed a 21-handle for the first time.
And as that CNHJPY > 21 persisted, PBOC decided to just lift the foot off the gas of aggressively stronger yuan fixings for just a day.
And it worked - CNHJPY dropped below 21 and back into the (still high) 20-handle. But doing that had awakened USD vs yuan bulls - which, I'm sure they had expected to some degree. But nonetheless, PBOC so far was able to strike the market balance between stopping CNHJPY upside and reversing off its highs, while mitigating USDCNH from exploding upwards. For now.
This is why it matters if the “post-BOJ” USDJPY upside rally is (incorrectly) attributed solely to “USD strength,” rather than JPY weakness as I had made it a point to distinguish "USD↑" vs "JPY↓" in my previous article.
Why does JPY weakening against CNY concern China?
Currency and Trade
Japan has been posting record high export figures - thanks to China, and a weak yen. Exports to China were up +30% for January, compared with exports to the U.S. at +15% and exports to the E.U. at 14%.
This marked the second consecutive month of robust export figures to China.
Other Measures of Yuan and Yen
In addition to spot exchange rate pairs, look at JPY as measured by key yuan index baskets monitored by PBOC: CFETS (China Foreign Exchange Trade System) Index, and BIS (Bank for International Settlements) Effective Exchange Rates Index - and you will see that indeed JPY is getting hammered vs China’s currency.
CFETS - China Foreign Exchange Trade System
As measured by the PBOC’s CFETS basket, the yuan is actually not getting hammered as a straight USDCNY chart would suggest. But that is also a function of their weightings adjustments made to the basket - in which the weightings of the US dollar and the euro were both decreased. And by lowering the weightings (and thereby the strength influence) of USD and EUR, that actually shifts a bit more weighting towards JPY - so, as USD and EUR strength was given less weighting, JPY’s crushing was given more, for a CFETS RMB basket that has held up.
China to lower dollar, euro weightings in CFETS yuan basket index in 2024
“China will adjust the weightings of two key yuan index baskets… to better reflect trade patterns.
From Jan. 1, the China Foreign Exchange Trade System (CFETS), which is overseen by the central bank, will lower the U.S. dollar's weighting in the CFETS currency basket to 19.46% from 19.83% and cut the euro's weighting to 18.08% from 18.21%
Such adjustments are unlikely to create sharp volatility in yuan trades, but they may affect the setting of the yuan's official daily midpoint fixing, which caps the spot trade in a narrow range of 2% around that level, market watchers said.”
But if you look at central parity rate charts of CNY vs USD, EUR and JPY - you can see that as the latter two (USD and EUR) remained more or less flat vs CNY, JPY has been plunging, and thus has been the elevating factor for an uncompetitive trade stance.
BIS Effective Exchange Rates
Bank of International Settlements Effective Exchange Rates (EER) explained below:
“The BIS effective exchange rates data set covers long time series on nominal and real effective exchange rates. They can serve as a measure of international competitiveness, components of financial conditions indices or as a gauge of the transmission of external shocks.
The broad effective exchange rate indices cover 64 economies. Narrow indices include 26 and 27 economies for the nominal and real indices, respectively. Nominal effective exchange rates (NEER) are calculated as geometric trade-weighted averages of bilateral exchange rates. Real effective exchange rates (REER) are derived by adjusting the NEER by relative consumer prices.”
https://data.bis.org/topics/EER
And indeed, if you look from 2000 onwards, BIS’s Real Effective Exchange Rate also shows China holding up despite the past 2 years’ declines in REER, and the yen getting decimated, particularly over these last 2 years.
BIS Real Effective Exchange Rates Since March 2022 (Fed Rate Hikes)
So, by many measures, China felt that the yen was getting too cheap, too quickly - and on Friday, had for once, acted upon JPY, rather than upon USD, by letting the midpoint fixing go slightly less strong. It was not a shift in policy stance to allow for a weaker CNY line in the sand and accommodate for further PBOC rate cuts (as this week’s rush back to yuan strengthening measures shows) - it was yen-induced.
China State Media
State media making it a point that the yuan had strengthened “last week” - a news headline and article who’s existence would be pretty meaningless on its own, but does serve a purpose if overall sentiment and concern about yuan devaluation due to a single day sharp move takes hold.
"Non-story articles” like the above are there to try and calm any self fulfilling nerves (and corresponding activity) of a coming yuan avalanche for the China domestic yuan holders. Such state-media pieces can also serve as a signal for what the intention, desire and/or priorities of the PBOC/party are to people like myself. It doesn't signal what markets will do, but it does reveal at least a hint of what direction the policy effort is, as well as the absence or existence of policymaker concerns themselves.
So, in current practice and application: My uncertainty as to what the Friday yuan non-support was all about and whether or not it may have been the start of a policy shift away from months (years) of daily yuan support, even with the following Monday aggressively strong yuan fixing to reverse the previous session's weakness- the state-media article above gives me signal that PBOC is: a) surprised / freaked-out about the magnitude of the intraday yuan move on Friday just from taking their foot ever so slightly off the gas, and b) is still very much preferential towards yuan strength (or, very much not ok with yuan weakening) - vs USD.
Market Implications: CNH/JPY vs US Yields
Since the yuan is technically pegged to USD, then CNH/JPY should generally behave similar to USD/JPY - as per USD and CNH movements relative to JPY would be similar by the nature of the dollar-yuan peg.
And since USDJPY and US 10Y yields are often highly correlated, then CNHJPY and US 10Y yields should also be similarly highly correlated, due to the above dynamic. As visible here:
However, if you zoom in closer to the last few days from when this sudden yuan sharp downside occurred, you’ll notice that of the two currency pairs USDJPY and CNHJPY, its actually the latter - CNHJPY - that keeps closer pace with US 10Y yields, and not USDJPY.
…and as I write this, USDJPY just jumped and broke through that 151.96 Oct ‘22 yentervention high to print new multi-decade highs - and why? What catalyst occurred?
Take a look at the live chart below and you tell me.
For the rest of this week (or for however long USDJPY 152 resistance holds) - WATCH USDCNH and USDJPY / global markets at PBOC daily fixing at 🇨🇳9:15AM (🇯🇵10:15AM, 🇺🇸EST 9:15PM) - and market open reaction thereafter at 🇨🇳9:30AM onwards.
And the market scenario assessment from previous note below still stands:
If China is (for whatever reason) allowing for some CNY weakness in the immediate, even if it’s just to the November 2022 lows, and Japan MOF steps in to yentervene at USDJPY higher highs each time, then we may get some potentially extreme volatility as USDJPY breaks 152+ for a few handles north before getting smacked downwards, then we can expect a period of potentially wild cross-asset volatility while Japan and China play chicken in FX markets. Unless you want to go long already elevated vol (which not for me) - there’s no trade here from my own perspective in that scenario.
But if Friday’s yuan move was some aberration, and after seeing how sharp the yuan intraday sell off was, PBOC is now back on full guard of the currency and caps USDCNH upside as they did this AM, and simultaneously USDJPY is at its very upper limit of perceived or real yentervention, as BOJ hiking bias vs Fed cutting bias for policy convergence at both ends does get realized (delayed as it may be)- going long JPY here with a tight stop loss seems like a very asymmetric risk / reward. Not with options- as JPY can meander at lows for god knows how long. Just directional long JPY via futures (which just rolled to a new contract on CME), or short USDJPY.
FYI - starting next week (April) - subscription prices will increase. Lock in current rates before the end of this week, and receive key insights on market developments out of Asia with global market impact - now more than ever. China is stuck between currency strength and weakening, as well as easing vs currency. Bank of Japan is moving the global rate anchor for the first time in decades, while the yen is hitting yentervention level lows for the Ministry of Finance. Japan equities are leading global DM equities in both upside, as well as activity and breadth.
If you’re not keenly watching Asia’s broad market impact on currencies, fixed income, equities (just about any macro green & red blinking ticker really), I have no idea how you would even attempt to navigate markets in any effective manner (other than pure luck + “only-Fed-matters” blinders).
Thank you all for your support and helping this platform grow.
Weston
Read the prior article on the topic below (unlocked from paywall)
In the most recent (3-27) article about the trading/export "forces" between China and Japan and therefore the importance of RMB/JPY, as well as RMB/USD & JPY/USD, you also touched upon JPY volatility (below) -- now a ridiculous, seemingly out of control ¥151.63 = $1 (@13:50 jst). Thanks for the careful descriptions of trading data.
Based on the above and the snippets below, is JPY long really a possibility? Isn't it more like MoF whack-a-mole? And how long is "long"? A month? 2 days? (Haha -- only half-joking)
You wrote: … going long JPY here with a tight stop loss seems like a very asymmetric risk
… and Japan MOF steps in to yentervene at USDJPY higher highs each time, then we may get some potentially extreme volatility as USDJPY breaks 152+ for a few handles north before getting smacked downwards, then we can expect a period of potentially wild cross-asset volatility
"Three of the largest sovereigns and their rate and currency policies are aligned for going long JPY: 1). 2). 3). …”
Cheers
Hey Weston, I've been missing you during this most recent mayhem. Trust all is well. Love to see a post like this one updated to dollar yen busting thru not just 152, but also 153, and your thinking on the next moves in yentervention. Does MOF let it get above 155, 160? Love your thinking, hopefully I will get to see more of it soon.