Calm Before the Dollar Storm

More evidence that the renminbi is still largely reacting to the U.S. dollar.

After August 2015, the onshore RMB rate and the difference between the one-month offshore and onshore RMB forward points show a significant impact on the central parity. While the US dollar index effect remains, we find no evidence of a role for the RMB exchange rate against the currency basket revealed by China in December 2015 in the fixing process.
The basket is there in case the U.S. dollar strengthens. Otherwise:
Since August 2015, however, the RMB exchange rate against the CFETS currency basket is more volatile than the RMB fixing against the US dollar.
The conclusion: the currency basket is a work in progress.
An interesting question is about the role of the currency basket. Managing a currency basket in an open and transparent way can be tricky for an economy of China’s economic power and financial strengthen. As China’s influence on global financial markets is expected to increase over time, managing a stable level of a currency basket exchange rate can lead to repercussions for smaller economies, which have their currencies in the basket. If the ultimate policy objective is to maintain a stable currency basket exchange rate for the RMB, then the existing evidence indicates that China is experimenting and exploring ways to achieve such stability and emerge from the shadow of the US dollar. China, during the transition period, has to carefully choose the basket of currencies and their weights to avoid moving away from the adversity of referencing to the US dollar to one of referencing to a currency basket.

Bloomberg: China Banks Buy More Dollar Forwards as Bets on Weak Yuan Wane
China’s banks bought more foreign-currency forwards than they sold in May for the first time in 17 months, signaling the lenders’ clients have turned more optimistic on the yuan as capital outflows abated.

Banks bought a net 8.6 billion yuan ($1.3 billion) of forwards from customers last month, the State Administration of Foreign Exchange said in a statement posted on its website on Monday. That compares with record net selling of 428.4 billion yuan in August, when policy makers devalued the currency, and is the first time the figure turned positive since December 2014.

Alhambra: ‘Selling Dollars’ Again
Again, in what is so far a repeat of “dollar selling” at the start of the month with payrolls, this calm isn’t corroborated anywhere else suggesting at best temporary influence. Stocks are up but that is again merely the opposite of CNY down = bad. Inside China itself, we find instead SHIBOR breaking above 2% as CNY fails to clear out more funding space (“devaluing”) in RMB. Violation of 2% in the overnight onshore interbank rate usually brings further CNY “devaluation” as the PBOC forces itself to reckon onshore first. Thus, it’s not clear how long these Brexit, GBP factors might muddy these dynamics.
...Instead, the Japanese yen continues its advance in the direction that CNY should likely follow before too long. This isn’t a direct correlation in small timescales, but as JPY goes up it signals the related pressure on CNY further in “dollars.” From this divergence with GBP, then, we can reasonably assume that Brexit “effect” for however short it might work (in overly simple terms, banks selling “dollars” against the pound appear to be filling any funding “dollar” gap for China due to Japanese/Hong Kong banks getting out, but leaving RMB to struggle because of the Asian direction).

...The UK referendum thus clouds the issue until Thursday. What happens thereafter is anybody’s guess, but in my view before too long Brexit fades and the Asian “dollar” takes over again. That seems to be the direction foretold by JPY, and even the Bank of Japan has learned to consider first the yen verdict.
Stress is building up in the system. The S&P 500 Index couldn't hold the rally on Monday, yen is pointing to trouble, USDCNY near its 52-week highs, European bank equities enjoyed a bounce but still in a clear downtrend. Specifically on the yuan, and the above on the Chinese banks: the bearish kinetic energy has been exhausted, but the bullish kinetic energy has barely moved USDCNY. The potential energy is mostly on the side of the bears now. The markets are remarkably calm despite a near 2-year high in the yen and a new low last week for Deutsche Bank (DB) among others.

Anything can happen in the markets, but a downside break will have multiple key "bear" assets trading at 52-week and multi-year highs. Even the bulls are bears: the 30-year treasury has a bullish cup and handle formation.
Yen and the S&P 500 Index have diverged.
I'll buy volatility.

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