One of our core medium-term investment themes has been for the emergence of a cyclically and secularly weak CNY, and we continue to hold to this view. The Chinese authorities’ current embrace of a weak-CNY is expected to persist, with the pace of CNY depreciation continuing to out-strip that priced into the FX forward curve. We also continue to favour positioning for CNY weakness via the NDF curve rather than the CNH offshore forward market, and accept paying wider forward points in return for reduced fixing risk. The method that the authorities have deployed to weaken the CNY has allowed the sizable depreciation seen over the past few quarters to go somewhat below the market’s radar screen. Nonetheless, continued CNY weakness may increasingly influence the performance of currencies and markets in Asia ex-Japan. The current liquidity driven rally in emerging markets may therefore provide attractive opportunities to short Asian currencies such as KRW and SGD, and also initiate some interest rate trades such as recieving KRW IRS and implementing SGD IRS curve flatteners. An additional appeal of a long-USD/CNY position is that the position contains an embedded long convexity component. There are growing non-linear economic risks associated with China’s economic slowdown given the combination of surplus industrial capacity, an increasingly inefficient allocation of capital and exceptionally high corporate leverage. These risk will increasingly require ultra-accomodative monetary settings to help limit the rise of credit risk and NPLs, and such a policy is consistent with a faster pace of CNY weakness. The unprecedented recent stability of the CNY IRS curve reflects the current policy stasis: PBoC is trying to strike a balance between supporting economic growth with low rates and limiting the rise in USD-demand; ultimately, as growth continues to slow the need for lower interest rates will prevail and the CNY IRS 2s5s spread is likely to steepen sharply as the fixing rate is allowed to decline.
The USD/CNY NDF curve continues to under-price the depreciation potential for the CNY
Source: Bloomberg
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