The Chinese Dragon - How it affects your FX trade

Thursday, January 28, 2010

China’s growth is mainly dependent on exports with a trade balance of around $200Bn a year each swing in western demand effects on Chinese growth.Last year with the credit crisis in its climax Chinese exports have slumped and with it Chinese unemployment surged and growth slowed.However since in China political stability is in direct link to constant growth, this is not something the Chinese government could afford. The Chinese government quickly stepped in to tackle the economic spiral with an announcement of an outstanding $586 billion of stimulus.The result was a strong boost in Chinese demand with imports of commodities such as Coal, Iron ore and copper surging.

The effect of china is in such global scale that China’s growth prospects effect the entire global risk play for Equities, Bonds and Forex.In the FX space it is the commodity currencies such as the Aussie and the Kiwi that are most sensitive.However the commodity currencies are not alone, the Yen for example is also strongly affected from Chinese sentiment. .Japan’s main export to China is consumer goods and unlike the Aussie and Kiwi the Japanese Yen is a counter risk trade and tends to be in opposite divergence to the Chinese growth story, although not always. The Yen’s divergence with China can sometimes be more complex than a simple risk play, as detailed below.

So how your FX position could be affected?

Watch the Chinese policy on the Yuan-Although the Yuan exchange rate is controlled by the Chinese authorities investors look at the Chinese Yuan exchange rate as an indicator of Chinese growth.During the last decade the Chinese central bank allowed the Yuan to appreciate more than 15% against the Dollar.However since the credit crisis has erupted the Chinese authorities left the Yuan exchange rate at 6.82 per Dollar to keep Chinese merchandise cheap thus encouraging growth and tackling unemployment.As long as the Chinese authorities are worried about unemployment the Yuan will be kept low.

Why is the Yuan exchange rate important? If the Chinese government allows the Yuan to appreciate it means the Chinese government is bullish on the Chinese economy and therefore all China linked trades should gain and risk appetite in general should rise.

Watch out of Chinese tightening policy- With a target of above 8% growth for 2009 of the Chinese government a 9.1% YoY growth signals the Chinese stimulus has been successful. In fact it has been too successful with Real-Estate prices surging and Bank lending expanding to new records. As a result the Chinese authorities are tightening monetary conditions to curb inflation and restrain asset bubbles. The Chinese authorities have instructed banks to lend less and raised the reserve requirements for Banks, an effective monetary tightening. Any further actions with respect to tightening monetary conditions are perceived as negative for Chinese demand and negative for risk appetite. Lately there have been some concerns that better than expected data might bring even more tightening.
Thus any economic indicators that will point Chinese growth is overheating can set the stage for further tightening and move investors to avert risk.

AUD, NZD-Tightening monetary conditions is bearish, higher Yuan is bullish

EUR- Tightening monetary conditions is bearish, higher Yuan is bullish

JPY- Depends, if the JPY is gaining on an improved economic outlook, as has happened for a few times this year when the Yen actually gained on positive news. In that case a stronger Yuan is Yen positive since if the Yuan is higher the BoJ will feel more comfortable to let the Yen appreciate against the Dollar. Why? Exporters in Asia look at the Yuan as a benchmark and try to keep their currency low as well to compete with Chinese exports. A higher Yuan should make them feel more comfortable to let their currency gain.

If however the Japanese Yen will continue to be a carry trade favorite than a stronger Yuan is JPY negative. A tightening in Chinese policy in such a scenario is Yen bullish.