Yuan Gone!

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By Mike Conlon | June 21, 2010

In a move that the market was anticipating and hoping for, the Chinese government announced that they would loosen the peg on its currency and allowing it to float more freely.  This hopefully will allow for greater balance in the global economy and help China curb inflation.

However, expectations for Yuan gains fall anywhere in the 3-5% range, as any appreciation will be gradual.  This news sent stocks and commodities higher, as this is seen as a vote of confidence by the Chinese.  But there is still much work to be done, as China needs to increase domestic demand to support balanced growth.

China has always been the “X factor” in the forex marketplace, as their currency peg and government intervention have created imbalances and uncertainties and have essentially impacted every financial market.  There has been increasing pressure on China to make this move, and perhaps recent dollar strength vs. the Euro has encouraged this change.

So this news is very welcome by the markets, and risk appetite is the theme of the morning.   Oil is higher this morning to $78.25 and gold reached a 1260 handle earlier.  The commodity currencies are higher as a stronger Yuan will increase Chinese purchasing power.

This week is pretty light for news, with the FOMC meeting and the UK budget report due out ahead of this weekend’s G-20 meeting.  The timing of the Chinese announcement is somewhat conspicuous, as it was expected that Yuan valuation was to be a major topic of discussion.

In the forex market:

Aussie (AUD):  The Aussie is higher on risk appetite, as the Chinese news has the market betting that Australia will be a major beneficiary of a stronger Yuan.  There’s no real news for the Aussie this week, so expect it to trade on risk themes this week.

Kiwi (NZD):  The Kiwi is higher for the same reasons as the Aussie, though we are going to get some economic data from NZ this week.  The current account balance and GDP figures are due out mid-week, which should reveal how the economy is faring and what the RBNZ may be thinking with regard to interest rates.

Loonie (CAD):   The Loonie is moving closer to parity with USD, as higher oil prices and risk-taking are drivers behind gains.  There is data due out from Canada this week, with CPI and retail sales figures expected to show the state of the economy.  In addition, Canada hosts the G-20 meeting this weekend.

Euro (EUR):   The Euro is lower this morning against all but Japanese yen, as potential benefits from the Chinese news is out-weighed by the austerity measures to be enacted to deal with the debt crisis.  European banks have agreed to publish the results of bank stress tests in July, which may or may not be a good thing.

Pound (GBP):  The Pound is mixed this morning trading lower vs. the commodity currencies and USD but higher vs. Euro and Yen.  This comes in advance of the emergency budget report due out tomorrow, which is causing increased volatility as the “fear factor” of measures to be enacted leaves the market both hopeful and concerned.

Dollar (USD):   The Dollar is lower on risk taking, as equity futures are up big time this morning and stocks are going to open higher.  This week’s FOMC meeting is expected to yield no change, but GDP data due out on Friday with other data could tell a different story.

Yen (JPY):   Yen is trading lower as selling in order to buy higher yielding assets is taking place.  In addition, the Nikkei was up some 2.5%.  The Yuan news is widely expected to be positive for Asian countries as a stronger Yuan should benefit other Pac-Rim exports.

I cannot underscore how big this news out of China is.  The market has been begging for this for some time to help re-balance the global economy.  However, the actual effect of this announcement and how it will play out is highly uncertain.

While it is widely expected that the Yuan will appreciate, I’m hearing rumblings that some analysts thing it could depreciate because of Euro zone issues.  While I think this is highly unlikely, the Yuan has been gaining ground as dollar strength due to the Euro debt crisis has lifted its relative value higher.

In addition, the timing of this announcement ahead of the G-20 meeting has bought China time and shifted the focus of the meeting back onto Europe.  How and when this actually occurs remains to be seen.

But this could end up being a case of “be careful what you wish for”, as unexpected outcomes could cause market uncertainty and increased volatility.  So don’t break out the Champagne just yet; as this move is both necessary and desired, but still a long way away from fixing the global economy.

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