Forex Investment and Currency Trading

The Chinese renminbi has traded in a range of narrow range of 6.8135-6.8527 per U.S. dollar over the last six months – except for a one-week period at the beginning of January, when it spiked to a peak of 6.8870. This spike is notable because it appears to have been a test by the Chinese authorities to international reaction to a weaker renminbi. The international response was forceful and the People’s Bank of China (PBOC) soon pushed the currency back into its previous narrow trading range against the U.S. dollar. While one cannot rule out further tests by the PBOC – particularly in the wake of the latest trade figures – market view is that the renminbi will continue to trade within its current trading range for the next six months.

As recently as last week, Prime Minister Wen Jiabao repeated what has become virtually a mantra by the Chinese leadership, stating that the renminbi would remain “basically stable”. While the term is sufficiently vague that a number of interpretations can be given, the popular sense now is that it refers to the renminbi versus the U.S. dollar. Had it been otherwise, the Chinese authorities would not have allowed the current stability versus the U.S. dollar to be established. This is important because if implies that any significant shift in exchange rate policy – without a significant shift in China’s economic environment – would entail a loss of ‘face’ for the Chinese leadership.

Forwards
The renminbi now trades at a discount to the U.S. dollar in both the onshore delivery forward market and the offshore non-delivery forward (NDF) market. Recognizing that the pricing of NDFs is determined in large measure by exchange rate expectations, there is dramatic change in forecasts of the renminbi. A year ago, the expectation was for a significant appreciation, but as the U.S. dollar started to rebound and the global economy moved into recession so expectations shifted toward a small depreciation.

According to estimates, as of January 2009, the CNY’s real effective exchange rate (REER) had appreciated 8.6% y/y and 17.5% since the mid-2005 currency regime change. This is a considerable appreciation and gives any China-based company much more buying power on the international market. Moreover, the CNY’s stability against the USD has meant massive CNY appreciations against the world’s commodity currencies in recent months. CAD-CNY and AUD-CNY, have depreciated 34% and 37%, respectively, from their peaks. In other words, commodity assets in Canada and Australia have gotten massively cheaper for any China-based company. Some analysts expect a return of some dollar weakness in H2, but they do not expect much movement against the major commodity currencies.