10 Mar 2010
Forex focus: All change in China?

Welcome to CantosCharts. My name is Simon Derrick. I'm Chief Currency Strategist at BNY Mellon.

Over the last two days we've had something of a euro centric focus. We looked at sterling and we've also looked at the performance of the euro.

Today however we're going to look a little further afield and we're going to look at one of the currency pairs that has been a key driver for so much of what's happened over the course of the last decade and that's the dollar against the renminbi.

It is actually an incredibly simple chart. The red line represents the performance of the spot dollar renminbi over the course of much of the last eight years and as you can see, it's a fairly straight forward story. We have the dollar peg lasting through until July 2005. We have the very steady appreciation taking place of the renminbi through that period and then, from July 2008, the de facto repegging of the renminbi against the dollar. Since that time, there has been virtually no variation in that price at all. Indeed, over the course of the last few months, the variations have become even more marginal.

What's interesting there is that speculation over a fresh move for the renminbi has not gone away and this is reflected in the performance of the blue line, or the one year non-deliverable forward (NDF). In other words, where the market is predicting the renminbi will be in 12 months' time against the dollar.

Through much of the period of 2005 - 2008 it wasn't overly difficult for traders in that particular market. The renminbi was appreciating at a steady pace and investors could work out fairly easily where the renminbi would be in 12 months' time.

Since then, however, you can see that there have been wild variations in the performance of the NDF and where the market is forecasted that the spot price will get to. Unfortunately, almost none of them have proved to be correct over that period of time.

We suspect that the market is still getting it wrong. There are a variety of technical reasons for that and a variety of political reasons for that, not least of which is the fact that there has been this heightened political tension between the United States and China over the last 12 months and China has a history of refusing to react to political pressure for change. We've heard very clearly from the Premier over the last four months that there will be no significant shifts. And although there was some speculation that the Central Bank Governor was indicating a change in policy, it's important to note that what he was saying was it would come sooner or later. In other words, there was no timeframe on that.

For the moment therefore, it seems to us that there will be no shift and on that basis, it seems reasonable to suggest that the spread between the spot price and the non-deliverable forward should start to narrow back towards zero.

And this brown line here represents the spread between the spot price and the one year NDF and as you can see, that spread has started to move out quite dramatically over the course of the last 12 months as people have been constantly predicting the idea that there could be a move in policy.

If you don't believe that's the case and you see this... actually, there is quite a neat technical correction this very clear downtrend here. It feels to us that actually the smart money will actually be on a narrowing and at the very least, back to par and possibly a little further than that.

For the moment, it seems to us that all the money is on a revaluation. If you believe what the Chinese politicians say, and it has always proved to be a wise thing to do when looking at the renminbi, then it seems to us that correction could take place and could take place quite quickly from here.

Thank you very much.