Yuan's risk remains on the downside, despite another record high trade balance

China’s August trade balance edged to another record high at CNY 49.84, as imports YOY dropped to the lowest level since March while exports lowered to 9% from previous 14.5%. But there is little reaction from USD/CNY as China is on holiday today.

- On a long term basis, widening trading deficit puts further upward pressure on Yuan and it will persist. Export environment in the remaining months of this year remains to be sound as global economic conditions continue to improve, plus the increasing currency usage. CITI DM economic surprises index has rebounded sharply since middle of July. Weaker commodity demand is likely to remain a drag on import growth.

- No aggressive stimulus needed so far. Average trade balance in 3Q is 1.68X to 2Q’s at CNY 28.77. HSBC China service PMI jumped to 54.1, indicating the consumption demand is picking up. Widening trade surplus and increasing consumption continue to ease those worries of a sharp fall of the 3Q growth, though property sector in China remain to be a main drag. In other words, a further broader easing measure in the near term is unlikely.

- Exports to EU could become a drag. Euro Zone is China’s second largest exports market. EUR/CNY has been trading below 8.00 after a possible ABSPP at EUR 700 billion introduced by Mario Draghi last week which deteriorated demand in the Euro zone, as seen from the falling lending amount, plus the falling German confidence index (ZEW, IFO) will negatively impact the Chinese exports to this region.

-Yuan may trade lower to 6.15 against the USD in the short term

1) Exports may fall in the following months as the volume to Euro zone and Japan could be lower.

2) No aggressive measure from the Chinese officials is needed at this stage, when the downside growth risk in 3Q is trimmed by the widening trade surplus.

3) Market overreacted to the Shanghai HK stock connection. Correction between the Shanghai composite index and CNY/USD is high this year; in other words, any retracement happened in the domestic stock market in latter part of the year should bring its currency lower. Shanghai composite index has been rallied 17.8% since the lowest level in May.

4) Strong U.S. recovery will benefit the Chinese exports, however it could accelerate the Fed to normalize the monetary policy and the USD set to appreciate.