China's Catch-22 Signals Stronger Yuan Surprise to Goldman Sachs

  • Higher yuan fixings to drive rally in risk assets, Brooks says
  • Currencies of Australia, Malaysia, Indonesia seen gaining

China is probably going to surprise markets by strengthening the yuan’s daily fixings over the next few weeks, driving a revival in risk appetite that will buoy currencies from Australia to Malaysia, according to Goldman Sachs Group Inc.’s head of exchange-rate strategy.

The nation is in a “Catch-22” situation whereby policy makers keen to stimulate the economy are finding that weakening the yuan’s reference rate tightens financial conditions by worsening an equities rout and capital outflows, Robin Brookssaid at a conference in Sydney and subsequent interview. Depreciation also triggers bigger declines in regional currencies, eroding the competitiveness of Chinese exports, he said. The People’s Bank of China raised the yuan’s fixing to a four-week high of 6.5419 a dollar on Thursday.

“Given that the market is so bearish on China, I don’t think you need to go back to 6.30 or anything like that, I think if you go to the low 6.50s that already would be a huge surprise for market participants,” Brooks said. “That will massively wrong-foot the market and actually set off a meaningful risk rally.”

An August devaluation followed by an eight-day stretch of weaker yuan fixings that ran through Jan. 7 roiled global financial markets and fueled concern China was favoring depreciation to help revive the slowest economic growth in a quarter century. The PBOC has at the same time been burning through its currency reserves to support the yuan amid record capital outflows. Already this year, global equities have lost 7.3 percent, led by a 22 percent rout in Chinese stocks.

Spillover Effects

In smaller economies, currency devaluations can restore competitiveness to exporters and stimulate activity, Brooks said.

“In China things are turning out to be much more complicated and, of course, they are learning about all the spillover effects on the rest of the world, which have bad feedback effects,” he said. “The discussion in policy circles in China, I can imagine, is maybe we have to step back from the currency for a while.”

The PBOC boosted its yuan reference rate by 0.16 percent on Thursday, trimming this year’s loss to 0.74 percent. Brooks said he expects the rate to be strengthened to about 6.50 per dollar in coming weeks, a move of around 0.6 percent, and predicts a year-end level of 6.60.

Stronger yuan fixings will probably drive a reversal of the currency trends that dominated at the start of the year, with concern about China’s impact on global growth having driven a 2.1 percent rally in the euro and a 1.9 percent advance in the yen. Worst hit among the Group of 10 currencies so far have been the New Zealand and Australian dollars, while South Korea’s won was Asia’s biggest loser.

“You’ll see the risk premia currently in the market that’s buoying the euro and the yen taken out,” Brooks said. The Australian dollar can probably rally 2-3 percent while currencies like the Malaysian ringgit and Indonesian rupiah will also strengthen, he said.

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