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Fundamental Forecast for the Yuan: Neutral
The onshore and offshore Yuan rates moved in opposite directions this past week: the offshore Yuan (CNH) held a bearish position against the US Dollar while the onshore Yuan (CNY) closed slightly higher on Friday. China’s financial markets were shut down on Monday for a national holiday, which led to no guidance on the Yuan rates on that day which started the divergence between the two rates through the week. Ahead, a heavy calendar will generate more volatility in the Yuan pairs. The top two economic reports that traders want to keep an eye on are the March Consumer Price Index and 1Q GDP reports. Further data to keep tabs on from China includes: retail sales, trade and new yuan loans figures.
China’s economy is facing two risks right now: a lower-than-expected growth and a surge in prices. The coming week will offer a good update of both. Earlier reports have shown improvement in the manufacturing sector. Both the state-issued PMI and Caixin PMI figures increased through March. Moreover, the state-issued PMI and Caixin PMI Services readings climbed above the 50 level, which indicates expansions. However, whether the economy has gained a solid foundation for a recovery is still in question. On April 8, Chinese Premier Li Keqiang said indicators in the first quarter have shown improvement in the economy; but because of global uncertainties, such improvements may not be stable. The 1Q GDP gauge is expected to drop to 6.7% from 6.9% the previous quarter according to Bloomberg. Last week, a member of China’s Monetary Policy Committee said that China’s 1Q GDP may come out slower than initial forecasts as the economy still faces downward pressure. A slower-than-expected growth will drag down the Chinese Yuan as well.
Even if we see better-than-expected GDP data, it doesn’t mean that all the fundamental issues have been resolved. Supply-side reforms are still ongoing. It will take at least three years for manufacturing companies to cut their production to target levels and relocate excess workers. The real estate sector is developing unevenly: while small cities are trying to reduce large stockpiles of unsold homes, large cities are struggling to control soaring housing prices within the regions. Non-performing loans are dragging down both banks and the state-owned enterprises (SOEs). Banks have become more cautious about issuing new loans due to increased risks (traders will want to watch the New Yuan Loan data next week). There is even some initial evidence that some SOEs are starting to default on their debt. China has introduced a series of new policies to deal with those issues; but as the old saying goes: Rome wasn’t built in a day. No matter how effective these policies are, they will not be able to cure everything overnight or a month. Therefore, the economy is likely to ride on more choppy waves in the long term, which means the Chinese Yuan will remain at risk to volatility.