• Despite the recent tough talk from the Chinese Premier, Wen Jiabao, we expect China to resume appreciation of the CNY vs USD soon. In this paper we present our case and look at the economic and financial implications.
    • It is now in China’s interest to appreciate the CNY as focus has shifted to avoiding inflation and asset bubbles. A currency appreciation will serve this purpose and help China to rebalance its growth from export-driven to domestic demand-driven.
    • We expect the CNY appreciation to resume in May with a small 1-2% one-off move followed by a gradual strengthening vs USD, totalling 5% over a year.
    • Given the relatively small scale of the expected appreciation the macroeconomic impact should be limited. However, it should be a step towards rebalancing the global and Chinese economies.
    • We believe the short-term reaction in equity markets is likely to be negative as any tightening in China is likely to make the market nervous. However, equities should quickly recover once the positive long-term effects are realised.
    • US bond yields are likely to rise in the short term on fears over vanishing Chinese demand for US treasury bonds. This should prove temporary, though, as it should become clear that China will continue to purchase US treasuries, as it did during the previous appreciation phase from 2005 to 2008.
    • In the FX market we expect the USD to strengthen initially but appreciation of Asian currencies should over time lead to more diversification of FX reserves and drive the USD lower in the longer term.
    • Commodity prices are likely to decline initially – but again we expect the effect to be temporary.