Asia Macro: A reminder that the PBoC’s not-so-invisible hand still deals the cards

I still think Asia is a big signal for upcoming dollar weakness. 

The yuan fix was friendlier than expected, and perhaps the policy shift on the weekend was a reminder that the PBoC’s not-so-invisible hand is still dealing the cards when it comes to the yuan. And while regulators welcome a stronger yuan, they do not welcome noncorrelated speculatively driven markets.

The PBoC moved to arrest the persistent selloff in USDCNH that’s been in place since May by reducing the costs of selling CNH. However, a rally in USDCNH should prove short-lived. Any upside pressure in USDCNH would be seen in the forward curve, which is contained in Asia open on Monday as implied one year is trading flat. 

After rallying briefly in September 2017, USDCNH resumed its downtrend early in October, selling off ~6% by the end of Q1 2018, before trade war concerns triggered a multi-month rally. For now, a growing bilateral trade surplus with the US and a pronounced recovery in China’s manufacturing output, relative to consumer spending, point to ongoing fundamental pressure in driving USDCNH downside.

US stimulus talks continue without compromise. However, any negative impact on US equities and USD upside are being offset by growing fiscal spending expectations under a Biden presidency (65% PredictIt) and a Democratic sweep of Congress (88% House, 65% Senate). Democrats rejected a near $1.9 trn offer from Treasury Secretary Mnuchin over the weekend, with federal unemployment the main sticking point. This saw equity markets and risk sentiment wobble at the open, but remain bid on dips.

At this stage it appears the only risk that could upset the US equity apple cart over the next couple of weeks is a recovery for President Trump in the polls that raise his prospects of re-election and another split Congress, which would undermine stimulus expectations.

Volatility was relatively mute last week but could be the calm before the storm ahead of some significant catalysts, including Q3 results, the Chinese Communist Party's plenum October 26-29 and the US election on November 3. So we should not be surprised to see profit-taking in a handful of crowded sectors.

Forex 

Flows in G10 have been exceptionally light, but – largely due to the collapse in forward vols –  I think the short dollar momentum trade will continue into the election, barring negative vaccine developments, and there will be extremely positive decay. 

Global growth is now only marginally lower than it was before Covid-19, yet the benefits have not yet been felt of extremely loose financial conditions; under the surface, equities have started to price the election outcome very favorably, especially the cyclical exposed EU stocks,  and expect currencies to continue following in suit. 

FX traders were taking a lively read for cyclical-heavy Europe, and thought of a Democratic sweep could well be the catalyst for some real rotation into Europe. Both macro and longer-term strategic funds have been buying the EURUSD in earnest the last few weeks to redeploy in a European equity cyclical binge. But the top side attempts have been running into a lot of supply from interbank types due to the resurgence of Covid-19 in the EU and a more dovish spin on the ECB. That supply appeared to give way on Friday, likely due to a Biden widening in the polls. 

The RBA was dovish as feared with minimal price into fixed-income markets, which led to some AUD underperformance.

Overall when the FX markets digest and clear the PBoC’s push-back on the yuan, short dollar positioning could start to build up again since it’s nowhere near the size it as before the washout, so I'd expect popular trades like long Euro and gold to retest the cycle highs pretty easily in the coming weeks.

Gold

After receiving a shot in the arm when China came back from holiday and didn't do anything to fix USDCNY higher – which allowed USDCNH to touch new cycle lows not seen since the happy pre-trade-war days of early 2019 – the PBoC’s push back on the yuan has predictably reversed out some of the froth in gold, but dips are being bought, given no shift higher in the yuan forward curve.