Markets haven’t always known where to look over the past couple of weeks as high volatility has been witnessed across all sectors. USD funding stresses look relatively well contained thanks to swap lines at respective international central banks allowing the demand for Dollars not to spill through to foreign exchange. However, the market has awoken today to yet another risk to foreign exchange market stability and this time from Asia. Overnight, severe equity market weakness has spilled over across asset classes. In particular, China and the role of the Yuan could disturb normalising volatility conditions across the wider market.
There are two main risks to the stability of the Yuan. To provide some context, the offshore and onshore Yuan have demonstrated considerable volatility over the last few trading sessions. With the Yuan having lost almost 1.5% versus the US Dollar over the past three trading sessions, a relatively rare move by volume given the active management of the Yuan by the monetary authorities in China, markets could be braced for a more dramatic shift. In fact, the market moves over the past three trading sessions have provided more volatility to USDCNH than the rest of the trading year to date.
The first reason to expect further volatility is that China seems to be continuing to define its position with respect to the Russian invasion of Ukraine. Yesterday, admonitions from Western nations that those who do business with Russia will not be able to do business with much of the international economy are still to be digested in international relations. There is still considerable uncertainty in determining China’s role in applying or undermining sanctions on Russia which could create significant volatility once again within Asian FX.
The second risk that has emerged is an outperforming domestic Chinese economy. Robust growth and spending has prevailed despite social mobility restrictions being imposed to limit the spread of Covid-19 during both the Winter Olympics and the Chinese New Year festivities. Retail sales were most recently recorded at 6.7% year-on-year which highlights strong consumer spending within the population. This means that the relatively accommodative PBoC will likely be able to maintain current financing conditions without adding additional monetary stimulus to the economy. Given the number of risks presented to this geography, there remains a high probability for considerable volatility within Asian FX.
Discussion and Analysis by Charles Porter