The Rise and Fall of Chinese Yuan

27 дек. 2022 г.

CME: USD/Offshore RMB (CNH1!), COMEX: Copper Futures (HG1!)
Two weeks ago, China abruptly overhauled its strict Covid policy that had been in place for nearly three years. Lockdowns, health codes, massive testing, and domestic travel restrictions are no longer enforced. “The world changed overnight,” said one of my friends.

From Zero-COVID to “Lying flat”, the literal translation of a Chinese term which means doing the bare minimum to get by, this is a 180-degree policy reversal. It brought overwhelming joy and fear at the same time. People rejoiced over a long-overdue normalization of life and work but feared for surges of widespread Covid infections. I am sending my prayers and hope that a weaker Omicron virus would result in less severe health issues.

China’s reopening could have significant implications to its economy and to financial markets. Today, I focus on its currency, its stock market, and the global commodities markets.

The chart above illustrates how the Chinese Yuan (aka RMB) has moved up and down during the 2-year trade friction and 3-year Covid:
• In 2018, President Trump imposed import duties on thousands of goods originated from China. This sparked a Tariff War that met with retaliation from China.
• As tension escalated and tariffs raised from both sides, the USD/RMB exchange rate depreciated 12%, from 6.28 in March 2018 to 7.16 in December 2019.
• After nearly two years, the two countries signed a First Phase Trade Agreement in January 2020. The Yuan rallied 4% to 6.87.
• Two weeks later, Covid broke out in Wuhan, the capitol city of Hubei Province in central China. It shocked the world. As the pandemic quickly spread all over China and to the rest of the world, RMB depreciated back to 7.16 in May 2020.
• As China’s Zero-Covid policy quickly restored its manufacturing, the “World’s Factory” ramped up exports to other countries which were still shut down by the pandemic. The Yuan rallied again, all the way back to 6.3 by February 2022.
• The citywide lockdown in Shanghai, China’s largest city, was a turning point. Yuan nosedived to a record low of 7.3.
• Finally, the opening of Chinese Communist Party (CCP)’s 20th Congress in October and November signaled a change of courses. With Zero-Covid ending a month after, the Yuan is now back up to around 6.95.

In my view, China’s relations with the West are the key driver of RMB/USD exchange rate. When China embraces the world, Yuan goes up. When it decouples from it, Yuan goes down. As the time of writing, RMB has rebounded 5% in 2 months. I expect Yuan to further appreciate in 2023.

China’s Stock Market
China’s Shanghai Stock Exchange (SSE) index moved sideways. The five-year cumulative return is -7%. This highlighted the severe impacts delivered by both the Trade friction and Covid on the Chinese economy. By comparison, the S&P 500 yields +80% for the first four years. Even after the big selloff in 2022, its 5-year return is +45%.


We are witnessing initial chaos from reopening and Covid surges. After time goes by, I expect China’s stock market to rebound in 2023. For certain, the Chinese economy faces a lot of headwinds. However, massive bailout from the State is on its way. Next year is a year for stock picking. State-run enterprises are in a better position to receive government stimulus disproportionally. My suggestion is to follow the money. Keep an eye on industries and companies which benefit the most from State economic policy.

Commodities Will Get a Lifting
China’s reopening is welcoming news for commodities. Take CME Copper Futures (HG) as an example. Since the past summer, the base metal had been beaten down by 20% amid the market fear of recession. However, it moved above its 50-day MA in November, as the end of CCP’s 20th Party Congress signaled changing courses.


I am also bullish for agricultural commodities. With people going back to work and regaining income, consumption for corn, soybean, wheat, pork, beef, and poultry shall increase next year. This is good news for big exporters such as the US, Brazil, and Argentina.

Takeaways:
1) CME CNH Futures may continue to pull back due to US dollar softening and China reopening. Please note that CNH is quoted RMB per USD. If the Yuan appreciates against the Dollar, futures price would fall. Therefore, if you are bullish on Yuan, shorting CNH is the proper action.
2) SSE stock index may rebound, but we are better off picking individual stocks benefiting from government stimulus. For investors who can’t trade China’s stock market, you could search for Chinese companies listed in Hong Kong, or their American Depository Receipts (ADR) listed in the US markets.
3) Copper (HG) continues to weigh in between demand reduction from global recession and potential demand increase from China’s reopening. In my opinion, recession has already been priced in. The end of Zero-Covid would be an extra booster. Copper could erase its 2022 loss once China factories are pumping out products once again.

I wish everyone a Happy New Year.

Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.

CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs tradingview.com/gopro/