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Charlie Awdry, Chinese Equities Portfolio Manager, provides his views on the central bank’s symbolic move to allow the yuan to weaken below 7.0 against the US dollar and its significance for investors.
Today the Chinese yuan (CNY) finally broke through to the downside to the psychologically important level of 7.0 to the US dollar. 7.0 was a clear line in the sand defended by monetary authorities in Beijing since late 2016. While we are not currency experts, we would not be surprised to see the yuan weaken further now that 7.0 has finally been breached.
Many will say this breach of 7.0 is a political decision as part of the US-China trade war, but the economic theory of ‘the impossible trinity’ suggests that over the medium term, policymakers cannot simultaneously control domestic monetary conditions, the cross border movement of capital and the foreign exchange rate. The move shows that Chinese policymakers are finally giving in to this reality after a period of weak growth and ineffective policy responses. Perhaps it is merely convenient for the CNY to weaken through 7.0 now under the cover of the trade war?
The question of what this means for Chinese equity markets is a complex one to answer and is made more difficult by the extra volatility brought about by lower trading activity in the Northern Hemisphere’s summer holiday month of August. That it is happening just as the political situation in Hong Kong is becoming more combustible is an extra cause for concern in what are traditionally very emotional Chinese equity markets.
We will be monitoring the situation but it is probably fair to say that, if corporate China has seen the People’s Bank of China (PBOC) defend 7.0 to the USD for almost three years, those same corporates will have implemented a view that the CNY will not fall below 7.0 in financial decision making. While offshore funding is one obvious exposure, we will be watching to see where else risks will emerge.
This CNY move can be considered as a policy stimulus to the Chinese economy at a time when economic momentum measured by the Caixin Purchasing Managers’ Index (PMI) survey has been weak. Given our China equity strategy has a strong domestic demand focus, we will see if the currency move has a significant impact on consumer demand over time.