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An Emerging Divergence - Global Exchanges

FICC Podcasts 21 juin 2022
FICC Podcasts 21 juin 2022


Disponible en anglais seulement

In this week's episode, we discuss the reasons why the Mexican peso and Chinese renminbi have diverged so sharply in 2022. We give our thoughts on how long, and to what extent, this divergence can continue. We throw this out as one of our favorite summer trades--noting that it is a trade that should benefit in the event that oil continues to move higher.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Greg Anderson:

Hi, welcome to episode 46 of Global Exchanges, a podcast about foreign exchange markets and related issues. In this week's episode, my co-host Stephen Gallo and I discuss the reasons why the Mexican peso and the Chinese renminbi have diverged so sharply in 2022. We give our thoughts on how long, and to what extent this divergence can continue. We throw this out as one of our favorite summer trades, noting that it is a trade that should benefit in the event that oil continues to move higher.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London based FX strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York based FX strategist. I'm Stephen's cohost.

Stephen Gallo:

In each weekly podcast, like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets, like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to BMO.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO capital markets, it's affiliates, or subsidiaries.

Stephen Gallo:

Okay. It's the 21st of June, 2022. Thanks for listening to global exchanges. Greg, I'm happy to say we're breaking away from G10 for a while today to discuss a currency pair that's a bit more funky. China-Mex is the cross we're looking at. It's currently trading at three spot 0, 250. And if we look at returns year to date, Mex has had a roughly 7% gain versus the offshore RMB unadjusted for interest rates. The pair started the year at about three spot two, two and change. In terms of recent price action, back in early to mid-June, that was a period of heightened volatility in bond and equity markets. It looks like the Mex performed as the more risk-sensitive currency compared with the RMB. We briefly saw C and H Mex spike to a high of 308. That was in mid-June. But now it's back down again and just 4% or so above its low for the cycle. So Greg, what do you see as the key drivers of this move in the cross?

Greg Anderson:

So, Stephen, I think there are a bunch of interesting things going on underneath the move in China-Mex, but I think the first place we should start is probably with oil. Both countries are producers, but both are also not entirely energy self-sufficient. In Mexico's case, the country's a net exporter of rock [inaudible 00:02:51], but an importer of refined products. And when you put it all together, it's a tiny net importer of, we'll call it gray energy. However, China is much more of a net importer than Mexico. And while China does have state-controlled energy enterprises that are important to it, there isn't a national champion cash cow Petro company like Pemex is for Mexico. So I will start by saying that one of the reasons for Mex out-performance is the move-in Brent from we'll call it $80 at the start of the year to $127 a barrel on June 10th. Since then, till into last week in particular, we saw Brent pull back about 10%.

Greg Anderson:

And as that happened, we also saw corresponding pullback in the peso's appreciation against the renminbi. So I think that's story number one. But now I want to hand it over to you, Stephen, by repeating one of my key talking points over the last six months about oil. And that is that for this year's biggest FX move, the depreciation of the Japanese yen. The yen weakness is as much about oil as it is about Fed BOJ divergence. And with the size of the end move, there is bound to be some spillover over to China and other Asian currencies. Your thoughts, Stephen.

Stephen Gallo:

So I think there are two stories here, Greg. The first is that as you rightly point out, China is much more closely aligned with currencies like the yen and the Korean won, when it comes to the oil story and more divergent from the Mexican peso. But the second story, I think, is that due to fears over stagflation in the domestic economy or fluctuations in import costs disrupting their monetary policy stance, Chinese officials probably don't want the RMB underperforming other Asian currencies by a significant margin when energy prices are spiking higher, particularly crude oil. So to your point, there's definitely been a form of spillover to the RMB from the end depreciation. And that probably gives us another factor driving the weakness in spot China-Mex. Just to remind listeners of the returns in year to date terms, the Japanese yen has fallen by 14% against the US dollar, but the offshore RMB has dropped by a little under 5%.

Stephen Gallo:

And so that's the other point I wanted to stress, Greg, is that the spillover from the weaker yen to the RMB is definitely not a one to one type spillover. And that's partly a result of the fact that China is such a big importer of crude petroleum oil. And I think it's also partly due to the response from policy makers.

Stephen Gallo:

So, for instance, when I look at the value of Chinese crude petroleum imports, it has risen by more than 30% in USD terms year to date through may and crude petroleum imports are around 15% of total merchandise imports. That's reasonably large. But if I look at the growth of crude petroleum import volume, that was virtually nill it looks like over the same period. So it appears as if China's trade position has not been impacted negatively anywhere near the same scale that Japan's has due to the rising price of crude oil. And from a policy perspective, I think policymakers in China have likely been satisfied with that result in the sense that the RMB has not become an inflation headache while officials are pulling various levers to try and stimulate growth. So on the topic of inflation pressure, Greg, how much of there is it in Mexico?

Greg Anderson:

Mexico's markets for a lot of goods are integrated with the US's. So for things like food, consumer goods imported from China, used cars, the inflationary pressures that you see in the US are duplicated in Mexico. May's total CPI reading for Mexico was 7.65% year over year. And I would say Mexicans should be kind of proud, I think, that their inflation rate is a tad lower than the US's because the US's May CPI was 8.5% year over year. But, anyway, I guess the key point for the China-Mex cross is that Mexico is dealing with inflation on a seven handle while China is dealing with inflation on a two handle.

Greg Anderson:

Given Mexico's long history with sticky high inflation, Banxico started hiking long before the Fed. It's first hike was a little over a year ago from 4% to 4.25%. Banxico threw down its first 50 basis point rate hike in December and presently has a base rate of 7% with the market expecting it to match the Fed with a 75 basis point hike in a couple of days. I think, and it's market consensus, Banxico will probably get its base rate up to and maybe a little bit beyond nine double zero by the end of this year. So we're talking about a lot of monetary tightening undertaken in part with the intention of making sure that a rising dollar Mex exchange rate doesn't add to the inflationary pressures that are already there in product markets. So with that note, Stephen, how has Chinese monetary policy evolved this year and where do you see it headed?

Stephen Gallo:

The answer I think is loose for a while, Greg and headed in the opposite direction of the Mexican central banks and the opposite direction of the Feds. And that's probably for two reasons. First, because of the scale and nature of the monetary stimulus. It's not causing tremendous upward pressure on domestic inflation. So it's not been gargantuan stimulus. And the liquidity support, the local banks and the central banks are providing to the real economy is not flooding offshore and creating massive instability in the currency. So on that basis, policy can stay looser for longer with inflation as low as it is in China and the RMB basically stable. The second reason, I think we're likely to see loose for a while, Greg, is that following a major disruption in the property market, which is significant chunk of the real economy, policy stimulus just doesn't have tremendous traction. And the prospect of an export-led recovery seems to be dimming too.

Greg Anderson:

Stephen, isn't the loose monetary policy also just a match with China's continuation of its COVID zero policy, which has led to very little economic growth this year?

Stephen Gallo:

Yeah, that's true, Greg, it's the obvious direction of policy when you're enforcing strict COVID lockdowns at times looser for longer, but when you have low demand for credit due to a property bust and lockdowns, you can at times be pushing on a string, so to speak. You're not getting much inflation at all, which I guess is better than having too much inflation, but you're also waiting a long time for policy to gain traction and for confidence to be restored.

Stephen Gallo:

So again, this all fits the picture of China having wiggle room and, frankly, the desire to maintain loose policy for longer. And at the same time, if you're keeping local rates low compared to some of your [inaudible 00:10:17] peers, like, for instance, Mexico, your currency has to compensate for that to an extent by remaining towards the weaker end of the range. And Greg, interestingly, it's just a quick observation, but the Mexican peso doesn't seem to be at a level which is particularly expensive versus the RMB. So can I ask you two things, Greg? One, what are your thoughts on that relative valuation I just mentioned? And two, what's Mexico's COVID policy been like?

Greg Anderson:

Maybe I'll start with the second question first and just note that Mexico doesn't have anything remotely close to a COVID zero policy and never has. From the beginning of the pandemic, the Amlo administration didn't feel like Mexico could frankly afford to prioritize COVID spread minimization over the economy. Obviously it was, and it still is a painful choice, but most countries have moved to where Mexico's approach is very much the mainstream in 2022 while China's is more of the outlier. When it comes to valuation, I guess I would just say this: for dollar CNH, the average for 2018, 2019, so the two years prior to the pandemic, was 675. So at 669 now, we're call it 1% stronger for the RMB. For a dollar Mex, the average 2018, 2019 was 1920. And so here we are today at 2020 call it.

Greg Anderson:

So for the peso, about 5% weaker than where it was pre-pandemic. Put it together, CNH 6% stronger versus Mex than the average of the two years prior to the pandemic. So I guess where I'm going with all this is that, no, I don't think there's any valuation pressures that would get in the way of a further decline in CNH-Mex. And, in fact, it moved down to somewhere in the 280s, which was where we seemed to be headed quickly just a few weeks ago until oil sort of tailed off. Anyway, that would just be a mean reversion in the pair. And I tend to really like trades that combine mean reversion with positive carry. And this one certainly has some fairly healthy carry. More so than I'll call it the G10 cousin trade, which is long dollar yen. So with that, Stephen, is there anything else to add here?

Stephen Gallo:

I think so, Greg, I think it's important to emphasize that in the event of a risk-off spike in markets, kind of like we saw in early to mid-June, the trade is going to be China-Mex higher, and that is the risk to this trade not performing as well. But in that case, I think we just argue that fading rallies in China-Mex is probably the right way to be looking at this pair. And if you go off our latest year-end numbers for dollar-Mex and dollar-China in the FX quarterly, what we're basically saying is that short China-Mex still makes sense even if the currency pair stayed absolutely still because of the favorable Mex carry.

Greg Anderson:

So Stephen, should we wrap it up here?

Stephen Gallo:

Yeah, let's call it a day. Or an evening for those of us here in Europe. Thanks for joining us. Until next time. Bye for now.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the [inaudible 00:14:15] macro strategy group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

This podcast has been repaired with the assistance of employees, of Bank of Montreal, BMO Nesbitt Burns, Inc. and BMO Capital Markets Corporation. Together, BMO who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts. Not withstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or a suggestion that any investment or strategy referenced herein may be suitable for you.

Speaker 3:

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Speaker 3:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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