Forex Investment and Currency Trading

1 – 3 Month Outlook – Shifting Priorities

The pace of USD/CNY depreciation – both realised and NDF implied – has continued to moderate. The three month annualised rate of USD/CNY depreciation fell to just 1.0% in late-September, down from 6.6% a month earlier and a peak of close to 17% in March. Similarly, 12 month NDF’s have retreated towards the spot rate, when in March they were anticipating a 12% appreciation. In part, the slowing pace of CNY appreciation reflects shifting priorities on the part of the Chinese authorities as inflation has retreated and
evidence of slowing growth continues to accumulate.

However, there is also a risk of misinterpretation of PBoC policy. In the period since mid-July, when USD/CNY has essentially flat lined, CNY has registered gains against the other currencies that make up the other three “main” components of PBoC’s currency basket. Over this period, CNY is 8.0% higher against EUR, 1.0% higher against JPY and 16.9% higher against KRW. Taking PBoC’s commitment to move increasingly toward monitoring CNY against more than just USD, it seems a major reason for slowing USD/CNY depreciation is simply that USD strength is forcing adjustment through other currencies. On the face of it, there is some evidence that the weight of USD in such a basket is declining and the weight of EUR and JPY in particular is increasing. As such, and given the generally USD-positive stance, further CNY strength is expected through the non-USD components of the basket, particularly EUR.

6 – 12 Month Outlook – Slower appreciation

CPI inflation has declined to 4.9% from the April peak of 8.5%. This has given the PBOC room both to pare its 1-year lending rate and to instigate a reduction in reserve requirements. With external demand set to slow down materially, it’s expected to see further efforts to sustain domestic demand in the months ahead. Meanwhile, the appetite for currency appreciation has faded and on a 12 month view, USD/CNY is expected to fall to 6.50.

Indicators   Current (Previous)

Base lending rates 1 yr                                                  6.93% (7.00%)
Trend interest rates 10yr average                                  7.50%
Bias in interest rate market                                             Falling
CPI Inflation %Y/Y Aug (Jul)                                           4.9% (6.3%)
Inflation target                                                             -
Budget balance % GDP FY07 (FY06)                                 0.3% (-1.0%)
Budget balance target % GDP                                          -
GDP Growth %Y/Y Q2 (Q1)                                              10.4% (10.6%)
Trend GDP %Y/Y                                                            9.00%
Purchasing Power Parity Value Aug                              7.8008
USD/CNY end-Sep                                                          6.8485
Valuation                                                                   USD/CNY is undervalued
Current account balance % GDP CY07 (CY06)               11.3% (9.4%)
Trend current account balance % GDP                            7.50%
Moody’s Foreign Currency Rating                                    A1
Outlook                                                                        Stable