Conclusion: The past couple of days have provided some interesting commentary and data points out of Asia and the U.S. as it relates to the yuan, the yen, and the dollar. We remain bullish on the Chinese yuan from a TAIL perspective, bearish on the U.S. dollar from a TAIL perspective and bearish on the Japanese yen from a TREND perspective.
Position: Long the Chinese Yuan (CYB); Short the U.S. Dollar (UUP); Short the Japanese Yen (FXY)
The past couple of days have provided some interesting commentary and data points out of Asia and the U.S. as it relates to the yuan, the yen, and the dollar. While certainly not points of inflection within the broader context, we do think these incremental nuggets are worth consideration when formulating your intermediate-to-long-term currency outlook.
The latest unverified rumor out of China is that the central bank may allow the yuan to start trading versus the Russian ruble within 2-3 weeks. The rumor is based on a circulating central bank document which is proposing to allow Chinese banks to apply for ruble trading. Currently, China only allows trading of its currency with the U.S. dollar, Hong Kong dollar, Japanese yen, the euro, and the British pound and Malaysian ringgit. Extending these agreements to countries like Russia and potentially Brazil will increase cross border trade using the yuan, which more than doubled in 2Q10 vs. 1Q10 to 48.7 billion yuan ($7.2 billion). Natural byproducts of that include further upward pressure on the yuan and further downward pressure on the U.S. dollar, as it becomes less relevant internationally on the margin. We expect that to be bullish for commodity prices over the long term.
Data from Japan’s Finance Ministry shows that China bought more Japanese bonds than it sold in July for the seventh straight month (a sequential acceleration: net purchase of 583.1 billion yen in July vs. 457 billion yen in June). Unfortunately for Japan, this comes at a time when the yen is near a 15 year high vs. the U.S. dollar, creating massive negative implications for Japanese exporters absent Japanese government intervention in the FX market – which Japanese Finance Minister Yoshihiko Noda said he was willing to do yesterday.
This “crisis” has Noda essentially begging China to stop, saying today that “it’s inappropriate for China to buy Japanese bonds without a reciprocal ability for Japan to invest in China’s market… I feel strange that China can buy Japanese bonds while Japan can’t buy theirs.”
Putting these statements into context, we interpret these comments as Japan saying to China, “enough is enough”, given the economically damaging surge in the yen. Interestingly, a report from Barclays Plc. in Tokyo suggest that China’s purchases of JGB’s consist mainly of short term debt, which is a tactical move of sorts designed to take advantage of a rising yen.
China’s reply was in line with their recent displays of international power and influence: “Our management always adheres to security, liquidity, and good value. We will decide whether or not to buy one country’s bonds according to our own needs.” Let us recall that China has nearly liquidated its holdings of short term U.S. Treasury bills (98% decline since peak holdings of $210.4 billion in May ’09) in the context of a Burning Buck. As long as this trend continues (which is likely given Bernanke’s resolve to support the U.S. economy by any means necessary), we expect China to keep providing incremental upward pressure on the yen – further increasing the likelihood of Japanese government intervention to weaken the currency.
U.S. Treasury Secretary Timothy Geithner said today that China must let the yuan rise more quickly to show trading partners that it’s following through on its promises. He continues: “Frankly, they haven’t let the currency move very much so far. They know that they’re just at the beginning of that process and I think we’d like to see them move more quickly.” We’ve seen from month’s past that China has been reluctant to give in to external pressure regarding the yuan, so we doubt this round of badgering will end differently. It could, however, spur increased talk of anti-dumping legislation out of Washington. Just last week, Obama rejected a plea from U.S. manufacturers to increase duties on imports from China, though a Republican house and a GOP seat gain in the Senate could allow such bills to pick up momentum should the midterm elections end up as we expect.