EM Rundown: Panda-Monium in China

Giant pandas are an endangered species of bears native to south central China, that are seen as an international symbol of the country, but a EM traders were far more concerned with a different type of panda in today’s Asian session: the “Panda”-monium in the Chinese stock market. Chinese stocks collapsed by an incredible 7.7% today, after a regulatory crackdown on margin trading over the weekend.

Much like in the forex market, some stock traders use borrowed money secured by margin to trade large positions, though this practice is generally outlawed in China. Despite its legal ambiguity, margin trading has become a big business in the Middle Kingdom, with outstanding margin loans rising by 72% in the past three months alone to a record higher 767B yuan, according to the Shanghai Stock Exchange. The proverbial chicken finally came home to roost this weekend though, when China slapped a 3-month ban on opening margin accounts on three of the country’s largest brokerages. Through this action, Chinese regulators are hoping to head off a potentially damaging speculative bubble, and the immediate reaction was the largest percentage decline in Chinese stocks in nearly six years.

For now traders are looking at this development as a localized issue, with European equities closing higher across the board today; the DAX index even hitting a new all-time high intraday (for more on the German index, see my colleague Fawad Razaqzada’s report from earlier today, “DAX Pauses for Breath Ahead of ECB, Testing Key Level”). China’s regulatory crackdown has also had a relatively limited impact on the FX market with USDCNH pulling back modestly today after hitting a 7-month high at 6.24 on Friday. Nonetheless, the increased regulatory risk in the wake of this decision could put a damper on the economy of China and its closest trading partners moving forward.

Technical View: USDCNH

As we’ve noted before, the Chinese yuan is not a completely free-floating currency. Instead, the People’s Bank of China (PBOC) sets a “central parity rate” against a basket of world currencies (primarily the U.S. Dollar), and the currency is allowed to oscillate within a 2% band around that level. For reference, the PBOC set today’s central parity rate at 6.1230, meaning that it will allow the currency to fluctuate between 6.0005 and 6.2455. Because of this so-called “managed float” regime, the efficacy of traditional technical analysis is limited, though it can still help traders identify relevant trends and key levels within the trading band.

USDCNH is still holding near its 7-month high around 6.2400, but with the top of the PBOC’s band looming just above, further gains are unlikely unless the central bank raises its preferred level. This bearish view is bolstered by the appearance of a bearish RSI divergence at the last two highs. Therefore, a reversal off 78.6% Fibonacci resistance at 6.2360 is favored for now, with room down toward support at the convergence of the 38.2% Fibonacci retracement and 200-day MA near 6.19. On the other hand, if the PBOC starts to ratchet up its trading band, USDCNH could eventually retest the 2.5-year high at 6.2700.

Source: FOREX.com