Why There Is No Free Trade: Currency War Resumes – China Devalues Yuan To 5-Year Lows

After a brief hiatus from the ongoing currency wars, China fired another salvo at The Fed tonight by devaluing the Yuan fix to 6.5693 – its weakest against the USD since March 2011. After eight days higher in a row for The USD Index, it seems PBOC has turned its currency liberalization plan off, stabilizing the broad Renminbi basket (which has been steadily devalued) and turning its attention to devaluing against the USD. Having unleashed turmoil in August (pre-Sept FOMC) and January (post Dec rate-hike), it appears the rising rate-hike probabilities jawboned by The Fed are decidedly disagreeable to “authoritative persons” in China.

 

The Yuan Fix was driven down to March 2011 lows…

Front-running?

“It could be because the authorities want to alleviate some of the depreciation pressure before the Fed interest rate decision in June,” said Christy Tan, head of markets strategy at National Australia Bank Ltd. in Hong Kong. “If there are signs of panic dollar buying, the PBOC will step in.”

As it seems maintaining some ‘stability’ against the USD has lost its appeal as the USD surges once again…

 

What the chart above shows is that the Chinese currency (red) has been devaluing in an orderly and quiet manner for much of the year while maintaining the appearance of stability against the USD (blue). That appears to have changed now and the last time turmoil started to ripple through the CNHUSD markets – it didn’t stop until Tom Cook lied to Jim Cramer and The PPT rescued the world.

The irony of the apparent stability in the broad-based Renminbi basket (while devaluing against the USD) is that it comes after a desperate China has reportedly given up on its liberalization goals. As The Wall Street Journal notes,

Behind closed doors in March, some of China’s most prominent economists and bankers bluntly asked the People’s Bank of China to stop fighting the financial markets and let the value of the nation’s currency fall.

 

They got nowhere. “The primary task is to maintain stability,” said one central-bank official, according to previously undisclosed minutes of the meeting reviewed by The Wall Street Journal.

 

The meeting left little doubt China’s top leaders have lost interest in a major policy shift announced in a surprise move just nine months ago. In August 2015, the PBOC said it would make the yuan’s value more market-based, an important step in liberalizing the world’s second-largest economy.

In reality, though, the yuan’s daily exchange rate is now back under tight government control, according to meeting minutes that detail private deliberations and interviews with Chinese officials and advisers who spoke with The Wall Street Journal about the country’s currency policy.

On Jan. 4, the central bank behind closed doors ditched the market-based mechanism, according to people close to the PBOC. The central bank hasn’t announced the reversal, but officials have essentially returned to the old way of adjusting the yuan’s daily value higher or lower based on whatever suits Beijing best.

The flip-flop is a sign of policy makers’ deepening wariness about how much money is fleeing China, a problem driven by its slowing economy. For now, at least, officials believe the benefits of freeing the yuan are outnumbered by the number of threats… though we note that a 3% depreciation of the yuan could add $25.6 billion to Chinese companies’ annual interest payments on dollar debts, according to estimates by analysts at BNP Paribas.

So the question is – will the Yuan turmoil ripple through markets enough to spook The Fed once more and dissolve what little credibility they have left or will Janet and her henchmen stand up to the foreign forces, hike rates to spit their own face, and deal with the aftermath through some more Citadel-driven VIXtermination? With VIX futures near record shorts and S&P futures at their longest in almost 2 years – there’s not much easy leveraged money to squeeze there – like there was in August.

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