More Pain in Store for the Yuan

Market Trends - 13/10/2016

The Chinese yuan hit fresh six-year lows on Thursday, hurt by a spate of weaker than expected trade data. Exports fell the most since February amid tepid overseas demand, with the trade surplus edging below the $42 billion consensus estimate. The data was consistent with the visible slowdown in global trading volumes. Falling exports to the United Kingdom and the European Union indicate that the risks to Chinese recovery spurred by “Brexit” should not be ignored.  However, as China runs out of strategies to ward off lower growth, unshackling the Renminbi seems like the only viable alternative. Investors should remain wary of the export outlook given headwinds to investment and growth. As a result, it is likely the Chinese government will continue with its policy to revive domestic demand through an expansionary fiscal policy for the remainder of the year. Given the weak global demand for Chinese goods, exports could shrink further, adding to fears that the Yuan has much more downside in store.

The gloomy export backdrop merely highlights the many risks to an economy kept afloat by a burgeoning property bubble and massive fiscal stimulus measures.  The offshore Yuan is already down -3.40% year-to-date against the US dollar, the biggest decline among Asian currencies, with the Yuan shedding -6.20% against a basket of 13 major currencies. Considering the current trade environment, it is no wonder the People’s Bank of China weakened the daily reference rate on Thursday for the seventh straight session - the longest streak of weakening since the dramatic sell-off in January.  The government’s efforts to stabilize the housing market, coupled with easier monetary policy and higher US interest rates could trigger an even greater outflow of capital. While Chinese foreign exchange reserves continue to fall, outflows may turn out to be bigger than currently anticipated as capital exits the economy in Yuan terms rather than US dollars.

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