Is CNH market heading for a normalisation? - Natixis

Nordine NAAM, Research Analyst at Natixis, notes that since the start of the year, the CNH has appreciated by 2%, the USD/CNY weakening to 6.7875 before recovering to 6.89.

Key Quotes

“The CNY has not appreciated as much, as a result of which the CNH-CNY spread is tight by past standards, while forward rates at 12 months and over have declined. This has led to a sharp upturn in 1-month implied volatility to almost 8%, but nonetheless it remains subdued compared with the levels observed at the start of 2016.”

“This appreciation of the CNH is due chiefly to the bout of weakness experienced during the first week of 2017 in reaction to the publication of the FOMC minutes (words of caution concerning Donald Trump’s economic programme, notably as regards public spending and regulations) and to the protectionist rhetoric of the president-elect (pressures exerted on US carmakers to relocate operations in the US). The CNH has appreciated far more than suggested by the DXY dollar index, to which it has been rather closely correlated since the start of 2016.”

“The overreaction of the CNH is the consequence of a squeeze on this currency in reaction to a rise in money market rates in Hong Kong. In reaction to these developments, it seems that many short positions on the CNH were squared, which fuelled a technical rebound by the currency.”

“We doubt the CNH still has much upside potential. At the start of 2016, the appreciation of the CNH came when the US dollar underwent a downward correction (that lasted seven months), which we do not see happening this year. The US dollar can be expected to appreciate, fuelled by hikes in the Fed Funds rate and the strong US economic growth. A trade war with the US would be negative for the CNH. On the other hand, the CNH should weaken more slowly than in 2016 given the latest capital control measures, in particular the incentive for state-owned enterprises to exchange their foreign currencies for the Chinese currency.”

“The lesser capital outflows should lead to something of a normalisation of money market liquidity conditions, then to an easing of money market rates, mirroring developments in 2016 (after money market rates rose sharply in reaction to the lesser liquidity). Last year, the 3-month rate set a high at 10.12% on 12 January 2016, but then pulled back to its 5% pre-crisis level on 29 February. PBOC was forced to reduce bank its reserve requirement on 28 February in a move to boost liquidity after the crisis carried over into February. Unless there are further strains (Trump factor), it seems reasonable to expect money market rates to undergo a normalisation in coming weeks, but probably at a slower pace than in 2016, as the new capital control measures will lessen somewhat liquidity in the HKD market.”