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Peak USD? - It Will Depend on the RMB! - Global Exchanges

FICC Podcasts 10 mai 2022
FICC Podcasts 10 mai 2022


Disponible en anglais seulement

In this episode, we discuss the ongoing USD rally, ADXY weakness, and their potential feedback effects on the Fed.


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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.

Podcast Disclaimer

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Greg Anderson:

Hi, welcomed Episode 42 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson for this week's episode, my co-host Stephen Gallo and I will be talking about the ongoing us dollar rally, Asian currency weakness and their potential feedback effects on the FED. The title for this week's episode is Peak USD: It Will Depend on the RMB.

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 in 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 bmocm.com/globalexchanges. Thanks for joining us.

Announcer:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates or subsidiaries.

Stephen Gallo:

Hey Greg, May 10th, 2022 is the date and we're just over a month into Q2. And looking at the FED's broad trade-weighted index, it's moved about 4% higher in just over a month. And what's interesting about that move is that it can be partly blamed on the FED, its accelerated tightening plans and general hawkishness.

Stephen Gallo:

But the move looks like it has been even more heavily driven and affected by declining risk sentiment. So a number of higher B 10 currencies have underperformed in this move. A and so has the Asian currency space, notably a 6% drop in the renminbi, which is a bit less than the decline in the yen. So that's a very big drop in R and B terms.

Greg Anderson:

Stephen, I think that you're right, that the US dollar rally in the first few weeks of this quarter was driven by FED hawkishness just going back to March 31st as an anchor date at that point, the F Z two FED funds future. So, so that's the future. The price is in the overnight rate at the end of December. So right. You know, after the December FOMC at any rate, the implied rate from that future was two spot 25 on March 31st, by the time we got to April 20th, the pricing of rate hikes had added another 25 basis points. And so the applied rate was two fifty O over that 20 day interval, or so the FEDs brought nominal us dollar had appreciated about 1.3% in conjunction with that 25 basis points added to the curve. Okay. So advancing forward in time between April 20th and May 3rd.

Greg Anderson:

So this is the day before last week's FOMC FZ two added another rate hike, and the applied rate peaked it two spot 78% on last Tuesday's close. So adding this incremental 28 basis points to the curve that came along with 2.5% of us dollar index upside, since May 3rd, we've seen the dollar index rally, another about 0.6%, even though FFC two has now taken 18 basis points worth of FED rate hikes out of the curve over the past week. So I look at all that and say that, the first third or so of the US dollar rally was what I would call a benign FED on rally. And then the second phase is what I'd a risk off dollar rally, but arguably the risk off was coming from the market, worrying about the FED on for the last phase, since the FOMC, this is just a pure risk off rally, not caused by FED angst so much. It's caused about angst, about other things like falling equities and falling currencies.

Stephen Gallo:

Yeah, I suppose one of the factors Greg, that stands out across FX markets is how cheap commodity currencies have remained relative to our fundamentals. I think we can definitely link this to the risk off, move in the dollar, which is spilled over to equity markets and dragged Asian currencies lower pretty much like you just said, Greg, so let's drift into the Asian currency space now. And first off I fully admit to not expecting as much weakness in the R and B as we've seen thus far, but as we got into mid-April when dollar China, if you remember, was hovering a bit below six 40, it started to occur to me that there was a significant buildup in market expectations for policy easing from the P B C, and that if the central bank underwhelmed and opted for a more gradual pace, which it ultimately did, we were more likely to test levels above six 40, given the prospect for non-resident investors to be uneasy about reacting to R and B exposures without more aggressive easing from the P B C given the weakness we had already seen in other Asian currencies.

Stephen Gallo:

And so I covered the RMB from that angle in the FX daily on April 14th. And now here we are in dollar China at six $75.

Greg Anderson:

Dollar RMB at 6 75. And alongside that Ozzie USD at 69 cents, I'll admit to being shocked about both of those things. So with that move to 6 75, Stephen, I just wanted to point out when it all started, it started on April 20th. That was the date that Indonesia's finance ministry in central bank released on behalf of the G 20. What I would call a watered down communicate that didn't address what had to have been the two hottest topics of discussion among officials at the G 20 meetings. And those topics are FED rate hikes, and then the chaotic move in dollar yen. Chinese officials would've left those meetings in DC with the following understandings. First that the FED really was going to rip off at least a couple of 50 basis point rate hikes and move as quickly as it could towards at least a 2% base rate.

Greg Anderson:

Second that Kuroda and the BOJ were not going to raise rates or otherwise adjust policies that had caused the end to depreciate about 10% on the year at, at that juncture. And then lastly, the third thing they would've walked away from the meeting understanding well, is that nobody was going to physically intervene in the FX market to slow down the move in dollar yen. So with that understanding, Chinese officials seem to have somewhat stood aside as the RMB has depreciated the five to 6% that you mentioned Stephen over the span of just three weeks. So here's my question to you. Why shouldn't they just make it a nice, neat 10% depreciation and let dollar CNY move back up to seven double zero that would simply put the pair right back to where it was in December 2019 before the pandemic led to a roughly two year period of a strong RMB. What do you think?

Stephen Gallo:

A move to seven can be ruled out Greg, not completely. And we can do the cost benefit analysis around that size depreciation in the R B shortly. But what I think Greg, to answer your question is that the move in the R and B has elements of a market induced realign and a policy induced one as well. So both, firstly there have been portfolio investment outflows this year, as non-resident investors have trimmed the overweight exposures to China, they built up over the course of the last couple of years. So the supply demand balance between foreign and local currency on shore has shifted the R and B has responded as a result. And also note that the P B C trimmed the triple R on FX deposits with local banks in late April effective this month. So I think that's a reflection of that reality.

Stephen Gallo:

Secondly, China's been encouraging more cross border transactions in R and B and providing a bit more openness in the financial account. So they have to let the currency adjust flexibly if they want non-residents to continue to view the RMB as a viable reserve currency, especially since R and B debt yields have, have remained weak. They've they've been declining. Thirdly, in theory, a more attractive valuation for R and B assets in foreign currency terms should eventually attract more inflows when the currency stops falling. The other important fundamental to note, Greg, is that unlike other EMS, some of which have high inflation China's relatively low inflation backdrop is allowing the central bank to diverge from the FED on policy. So at the moment, right now, the move lower in the R B is not a distress move. The fundamentals stack up and P B O C is using administrative measures to manage the pace of the depreciation.

Greg Anderson:

So Back to the cost benefit analysis of a move to seven double zero in dollar R and B, correct me if I'm wrong, but I assume that China doesn't need to worry about the cost of that move. Getting out of hand, Chinese officials don't need to worry that in targeting a move to seven double zero, they instead get a move to seven 50 or higher because with capital controls and the amount of moral persuasion they have over their financial sector, they can stop a move in its tracks whenever they want it to stop. But what they can't control is what happens with the rest of dollar Asia. If Dollar R and B goes another 5%, say to seven double zero, all the other ADX, Y currencies might also weaken 5%. And so might the yen, Ozzie Kiwi, et cetera, that are outside the ADX Y so another 5% in dollar R and B may only give you 1% or less in the CFEs index. And in the meantime, you destabilize global equity markets without knowing where that will lead in terms of systemic risk.

Stephen Gallo:

I think that's right, Greg, in other words, in terms of the costs, if there is a negative spillover from R and B weakness that causes other EMS to experience a tightening of financial conditions, or be forced in defending their currencies, China doesn't really get any of the benefits of a weaker currency. It mainly just harms some of his largest trading partners. And then when something breaks, China takes the blame for it. It's tough to know where the threshold between a good and bad R B depreciation really is though. Greg, if the move is orderly in the R B, China picks up a bit of competitiveness without triggering that much pass through to domestic inflation. And that's partly because weak domestic demand is curbing import growth. So from that angle policy makers in China, don't currently have to worry about a problem, but if global financial conditions deteriorate for other reasons, maybe that threshold between a good R and B depreciation and a bad one has reached sooner. And on that point, I'll go back to a factor you mentioned earlier that a rate hike or so has already been pulled out of the dollar curve and Asian currency weakness has likely been partly responsible for that. So let me ask you can a specific pace of RMB or Asian currency weakness or certain threshold in dollar RMB spill over to the FED and impact its tightening plans.

Greg Anderson:

I'll tell you what, a 10% in a quarter RMB depreciation would probably raise some eyebrows and even some blood pressure readings in Washington DC, particularly if that move was propagating to other currencies and adding to stress on equity markets. I came into the FX market during the Asian crisis of the late 1990s. One of the things people in the FX market talked about a lot in that time period was the butterfly effect. This notion that [inaudible 00:12:42] small moves in financial prices, like those of government bonds in Thailand or Danish mortgage spreads, those can ultimately lead to massive things like huge swings in dollar yen, American hedge funds going belly up and the FED unexpectedly cutting rates. So bottom line, I'm not even going to pretend to know the answer to your question with any type of certainty, but off the top of my head, I would say this, if the FED's broad nominal dollar index were to go back to its pandemic high of 1 26 on March 23rd, 2020, if we were to get to there, then I think the FED blinks now I'll point out that's only 5% away.

Greg Anderson:

And my guess is that a quick 5% depreciation in the RMB would propagate to other currencies to the point that it would be a 5% dollar index move. So bottom line on the FED speaking for myself personally, I think a 50 basis point rate hike is just so baked into the cake for June that I can't conceive of them not going through with it, but if we were to get 5% more of China led broad us dollar appreciation, then I think that maybe the FED might back off at that stage with a dovish hike, if you will, and signal at least that it's done hiking in increments of 50.

Stephen Gallo:

Those are excellent points, Greg. So I think we can conclude that this new paradigm for inflation we're moving through is proving to be a real headache for policy makers and investors globally. Not really a shock. I think we could see this coming, but moving back to the dollar, your comments in that last segment, make me think there are reasons to believe the move is starting to overextend. And we haven't even talked about us trade and fiscal deficits yet. Maybe we'll, we'll save that for a future episode on that note. Why don't we wrap things up here if you stayed with us for this long, thanks for listening until next time. Bye for now.

Speaker 1:

Thanks for listening to Global Exchanges, listen to past episodes and find transcripts@bocm.com slash Global Exchanges.

Stephen Gallo:

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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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