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FED POLICY AND CHINA’S CURRENCY – SHOULD WE BE CONCERNED?

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FED POLICY AND CHINA’S CURRENCY – SHOULD WE BE CONCERNED?

By Jade Fu, Investment Manager at Heartwood Investment Management

Financial markets have begun to price in a higher possibility of an interest rate hike in the US this summer. The consequent rebound in the US dollar has once again shone the spotlight on China’s currency, the renminbi. China’s central bank this week fixed the daily reference rate at the lowest point in five years. However, unlike in August 2015, when policymakers implemented a one-off currency adjustment, and in January 2016, when the renminbi was fixed lower than the market expected, global markets appear relatively sanguine about this issue for now.

Concerns are growing, though, that likely Fed tightening (albeit modest) and the prospect of higher US interest rates are likely to start to test markets and the resolve of China’s central bank in its policy of managing its currency. In particular, there are fears that the People’s Bank of China could be forced to take further steps to depreciate the renminbi in an environment of US dollar strength, thereby increasing the risk of another one-off currency intervention.

Steps towards reserve currency status

We believe this scenario can be avoided and expect that the authorities will manage the renminbi’s depreciation gradually and transparently – a feature that markets will learn to accept. Our long-held view has been that the Chinese authorities are not looking to aggressively depreciate the renminbi and spark a currency war to boost China’s export sector, which would risk both severe capital flight and economic instability.

Instead, we believe the Chinese authorities are looking to gradually depreciate the renminbi over time, as part of policymakers’ broader strategic objective to further integrate China’s economy and markets into the global financial system. Indeed, the renminbi’s inclusion in the International Monetary Fund’s Special Drawing Right in December 2015 represented an important step towards China’s currency assuming international currency reserve status. In particular, we expect the renminbi will be increasingly viewed as an alternative currency to the US dollar in Asia, as the domestic market infrastructure in China is developed, creating deeper and more liquid local bond and equity markets.

Of course, this year some of the pressure has been taken off the renminbi to depreciate as the US dollar has weakened. However, the renminbi remains expensive on a range of valuation measures. It has appreciated by nearly 20% versus the US dollar over the last ten years to 26th May, 2016, and 44% on a trade-weighted basis for the same period.[1]  It is also 30% overvalued on a real effective exchange rate basis {Source: Bank of International Settlements}.

A change of tack from the Chinese authorities

Finally, recent policy initiatives have focused on fiscal stimulus and an easing of credit conditions, and the authorities appear to be moving away from currency interventions. There has also been some improvement in the transparency of policymakers’ communications with markets in their efforts to avoid unwanted surprises, such as we saw last August and in January of this year. Hitherto, this change of tack from the Chinese authorities appears to be working and we have seen the policy of gradual currency depreciation playing out in 2016. We expect that this trend will continue and also believe that China’s currency performance will be assessed not just exclusively against the US dollar, but also versus a broader range of currencies.

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Dollar mixed after Powell, pound hits three-year high

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Dollar mixed after Powell, pound hits three-year high 1

By Kate Duguid

NEW YORK (Reuters) – The dollar reversed earlier gains on Tuesday morning after a dovish speech from U.S. Federal Reserve chief Jerome Powell failed to quell inflation fears, while the British pound rose to fresh three-year highs.

The growing likelihood that Congress will pass President Joe Biden’s $1.9 trillion stimulus plan has raised concerns about a possible spike in inflation. The recent rise in inflation expectations as investors bet on a post-pandemic economic recovery and the so-called “reflation” trade has hurt the dollar this month.

Powell’s speech on Tuesday did little to allay inflation fears. In remarks prepared for delivery to a Senate Banking Committee, Powell said, “The economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved,” the hurdle the Fed has set for discussing when it might be appropriate to pare back support.

“The new fear of inflation – he did try to cap down the worry a little bit,” said John Doyle, vice president of dealing and trading at Tempus Inc.

But, he added, “I think [Powell] is going to continue that line about holding rates low for a long time. I think he’s going to try to continue to be that reassuring voice for markets. Which is why we’ve seen a little bit of recovery in risk as he started to speak and the dollar dip.”

The dollar index was last at 90.115, 0.08% higher on the day, but off session highs after the post-Powell dip.

Sterling hit a new nearly three-year high of $1.412, last up 0.33% on the day, as investors stuck with their bets that a rapid rollout of the COVID-19 vaccine would allow the British economy to reopen over the next few months.

Prime Minister Boris Johnson on Monday laid out a step-by-step plan for ending the current British lockdown.

“The pound made the most noise on a quiet night,” said Doyle. In addition to the plans to end lockdowns, sterling has benefited in recent months from relief over Brexit and better-than-expected economic data, which diminished the chances the Bank of England would push interest rates below zero.

Elsewhere, the euro strengthened 0.07% to $1.216 and the Japanese yen, the worst performing major currency of 2021, remained down on the day despite the weakening in the dollar. The dollar was last up 0.02% at 105.09 yen.

(Reporting by Kate Duguid in New York and Tommy Wilkes in London; Editing by Steve Orlofsky)

 

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Dollar bounces off six-week low as traders prepare for Powell

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Dollar bounces off six-week low as traders prepare for Powell 2

By Tommy Wilkes

LONDON (Reuters) – The dollar rebounded off six-week lows on Tuesday as investors’ focus shifted to how U.S. Federal Reserve chief Jerome Powell might respond to resurgent inflation expectations, while commodity-linked currencies hovered near multi-year highs.

The recent rise in inflation expectations as investors bet on a post-pandemic economic recovery and the so-called “reflation” trade has lifted U.S. government bond yields. That had fed through to a higher dollar until earlier this month when the greenback resumed its decline.

Analysts expect Powell, who testifies before Congress at 1500 GMT, to provide some reassurance that the Fed will tolerate higher inflation without rushing to raise rates. That might calm bond markets and eventually weigh on the dollar, they said.

“Mr. Powell will very likely reiterate that the Fed is a long way from meeting its goals and that it will likely take some time before “sufficient progress” has been made to taper its bond purchase program,” UniCredit analysts said.

The dollar index was last at 90.143, up 0.1% on the day, having earlier fallen to 89.941, its weakest since Jan. 13.

Graphic: U.S. dollar index

Dollar bounces off six-week low as traders prepare for Powell 3

Positioning data shows investors overwhelmingly betting that a U.S. dollar, which has been dropping since last March, will keep falling as the world recovers from the COVID-19 pandemic.

“Only when the spike in U.S. yields becomes more disorderly and spills forcefully into risk assets, would U.S. dollar experience an across-the-board strength,” said ING analysts in a research note.

The euro weakened 0.1% to $1.2151. Euro zone government bond yields have also been rising but the rally took a brief pause after European Central Bank President Christine Lagarde said on Monday the bank was “closely monitoring” rising borrowing costs.

Commodity-linked currencies have been among the best performers in 2021. Surging prices for materials from oil and copper to lumber and milk powder have pushed currencies such as the Canadian, Australian and New Zealand dollars to their highest in roughly three years.

On Tuesday, the Aussie traded down 0.2% at $0.7903 having earlier hit a high of $0.7934. The New Zealand dollar was down marginally while the Canadian dollar was just below its Monday high.

Sterling hit a new nearly three-year high of $1.4098, up 0.3% on the day, as investors stuck with their bets that a rapid rollout of the COVID-19 vaccine would allow the British economy to reopen over the next few months.

Prime Minister Boris Johnson laid out his step-by-step plan for ending the current British lockdown on Monday.

Bitcoin, the world’s biggest cryptocurrency, fell sharply below $45,000 and was last down 15% at $45,953, extending its drop from a record set on Sunday of $58,354 as investors grow nervous about sky-high valuations.

The Japanese yen, the worst performing major currency of 2021 because rising U.S. Treasury yields can lure investment from Japan, fell again. The dollar was last up 0.2% at 105.26 yen per dollar.

(Additional reporting by Tom Westbrook in Singapore; editing by Emelia Sithole-Matarise)

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Stocks struggle as tech slide erases commodities surge

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Stocks struggle as tech slide erases commodities surge 4

By Danilo Masoni

MILAN (Reuters) – World shares struggled on Tuesday as a rally in commodity-related assets gave in to pressure on heavily weighed tech stocks and investors awaited reassurance from U.S. Federal Reserve Chair Jerome Powell on the path for monetary policy in United States.

European tech stocks were on set for their worst day in four months, down 2.7%, and futures on the Nasdaq fell 1.5% after losses in stocks like Apple and Tesla dragged the index down 2.5% on Monday.

“The prospect of a less dovish tone from central banks, sparked by rising inflation, is causing stock traders to reduce their exposure to equities, especially overbought sectors like tech,” said Pierre Veyret, analyst at ActivTrades in London.

The MSCI world equity benchmark fell 0.1% to fresh two-week lows by 1138 GMT, having earlier risen on gains in commodity-heavy equity indexes in Asia. S&P 500 futures also fell, and were last down 0.5%.

Tesla shares were set to plunge into the red for the year, hit by a fall of bitcoin, in which the electric carmaker recently invested $1.5 billion.

The level of angst was also reflected in equity volatility gauges which rose to multi-week highs, while on bond markets German and U.S. yields moved in different directions, even though both remained just below the highs hit on Monday.

After being knocked off from eight-month high by European Central Bank chief Christine Lagarde signalling discomfort with the recent surge in yields, 10-year Bund yields resumed their upward trend and were last at -0.297%.

Ten-year Treasury yields were steady below Monday’s one-year high of 1.394% and were last at 1.370%.

Fed Chair Powell is expected to be equally reassuring on the central bank’s dovish stance when he gives his congressional testimony at 1500 GMT in Washington.

“If there were already any expectations that Powell could try to calm down rates, then (Lagarde’s remarks) have just further cemented them,” said Giuseppe Sersale, strategist and fund manager at Anthilia in Milan.

Commodity prices strengthened again.

Oil prices jumped by more than $1 at one point, underpinned by optimism over COVID-19 vaccine rollouts and lower output as U.S. supplies were slow to return after a deep freeze in Texas shut in crude production last week.

Brent crude was last up 0.7% at $65.7 a barrel after earlier hitting a fresh 13-month high of $66.79, while U.S. crude rose 0.8% to $62.17 a barrel.

“Oil has been caught up in the broader commodities move higher, with a weaker USD proving constructive for the complex,” ING strategists led by Warren Patterson said in a note.

“Meanwhile, there is also a growing view that the oil market is looking increasingly tight over the remainder of the year”.

Copper prices meanwhile hit a 9-1/2-year high as tight supply and solid demand from top consumer China boosted sentiment.

In currency markets, the dollar briefly dropped to its lowest since Jan. 13 ahead of Powell’s testimony, while commodity-linked currencies hovered near multi-year highs.

The dollar index was up 0.1% at 90.137, with the euro flat at $1.215.

Bitcoin fell as much as 17%, sparking a sell-off across cryptocurrency markets as investors grew nervous at sky-high valuations.

(Reporting by Danilo Masoni in Milan; additional reporting by Anshuman Daga in Singapore; Editing by Ana Nicolaci da Costa)

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