Mizuho daily – BoE: Bark or bite? CNY Bulls: Too far too soon?

By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

BoE: Bark or Bite?

Further evidence of tightening US job markets, Biden dangling the $6 trillion fiscal stimulus and the BoE “bark” that H1 2022 may herald normalisation took a bite at bonds. The consequent surge in government bond yields on both sides of the Atlantic (10Y yields up 3-4bps for USTs and Bunds) was understandably led by (>5bps lift in) UK Gilts. Although the wider idea of continued recovery (with EZ catch up) concedes policy normalisation plans.

BoE’s bark was certainly heard by bond markets although it’s bite is “state-dependent”; given Q2 2022 normalisation flagged is subject to sustained post-furlough recovery. Regardless, yields reactions swayed FX, led by for Cross/JPY surge. by GBP/JPY led (with ~2% surge), followed by a 0.7% lift in EUR/JPY and 0.6% USD/JPY rally towards 110.

EUR though was mostly sideways around 1.22, given the matched, catch-up move in yields. AUD, despite stellar Q1 capex release, struggled with traction beyond mid-0.77; imaginably owed to RBA’s accommodation bias and China pushing back runaway commodity prices.

USD/SGD meanwhile mostly consolidated around mid-1.32, unfettered by USD/JPY surge (seen as Cross/JPY peculiarity), but equally mindful that USD/CNY slide below 6.38 partly reversed.

In other words, a softer JPY and limited EUR traction may be a dampener for SGD bulls; but perhaps more poignantly, CNY bulls stalling may have greater sway on SGD piggy-backing. Speaking of which, the elephant in the room is whether CNY bulls have gotten too far.

Have CNY Bulls Gone Too Far Too Soon?

To answer whether CNY bulls are a little too abruptly carried away, the merits of “fair value”, policy and geo-political arguments that have seduced CNY bulls must be examined.

Foreign exchange fair value is contentious affair given the myriad ways in which to skin that cat. Crucially, even if such a notion of was entertained, convergence to FX “equilibrium” is notorious for shifting goalposts and unpredictable timelines.

So to attribute sharp, sustained CNY gains to “fair value”/fundamentals is at best flimsy. Especially if one has an appreciation (no pun intended) of the CNY not quite being a freely floated currency, whose “equilibration” is further impeded by capital flow restrictions.

Lately, policy expediency is a fashionable, rope from which CNY bulls swing. Specifically, the idea of CNY appreciation being used to dampen of imported (mainly commodity) inflation. But this lacks nuance, ignoring realities of one-dimensional input cost containment, may be to the greater detriment of exporters; even if China does not subscribe to mercantilist policies. Especially as supply-side responses are preferred to tackle transitory cost pressures; especially as FX reponse undermines the “stable CNY” exchange rate guidance that the PBoC preaches.

For those, swayed by the dictates of geo-politics, two strategic considerations weigh in.

One is Beijing’s “dual circulation” model that derives advantages from a tilt to CNY strength. Another is the perceived benefits of CNY strength to sweeten the backdrop for US-China trade talks and generally assuage tensions from US Treasury’s grouse about chronic trade imbalances.

These geo-political arguments are not without merit, but lack nuance. Apart from pre-trade talk CNY strength being more a token than a trend, the critical point is  the degree to which CNY appreciation is beneficial to advance strategic goals without adversely damaging jobs.

What’s more, CNY gains on many fronts appear to be stretched vis-a-vis AXJ; up ~11% from a year ago and up ~3% in Q2 2021 (far ahead of most other EM Asia FX). And this has shown up as sustained gains in the trade-weighted CNY back to pre-trade war levels in April 2018. Taken alongside recent reminder by policy-makers that CNY is a two-way trade, it is hard not to caution appear that CNY bulls have pushed too far too quickly.

Credit: Mizuho Bank Ltd