Yuan Follows Dollar Down, But Not Up

Back in April I wrote Bear Market Rally in CNY Almost Over

One can't forget about the U.S. dollar. USDCNY is outperforming USDEUR, USDCAD, UDSAUD, USDJPY...and some of those foreign currencies have recovered their losses all the way back to August 2015. CNYUSD is still below its August 2015 levels. Big rallies in most non-USD currencies, but not a big rally in CNYUSD. CNY decouples from USD when USD is strong, and recouples when USD is weak.

Macro Man has run the numbers and found this is quantifiably the case.

Macro Man: QUANTIFYING THE SHIFT IN CHINA'S FX POLICY

It's notable, however, that we already see a large discrepancy in the R-squareds. Let's look at this year:

Hoo boy, there you go. The CNY is more responsive versus its basket than it's ever been (on an R-squared basis) when the dollar goes down, and less responsive (based on beta and nearly on R-squared) when the dollar goes up. The difference in each measure when the dollar goes down and when it goes up is striking.

And this is how the Chinese have managed to fool the world (or at least lull some parts of it into a false sense of security); buy allowing the RMB to "strengthen" (versus the USD) only modestly when the dollar goes down, the authorities manage to ensure that the RMB weakens considerably versus its reference basket. When the dollar strengthens, however, the CNY takes enough of the brunt that the basket barely moves, as we saw to some degree on Wednesday.

It's all well and good as long as the dollar trades sideways to lower; if trend appreciation ever reasserts itself, however, the Chinese FX mechanism will find itself in a spot of bother.

A couple of days ago I posted the U.S. dollar analog. If the greenback's history rhymes, there's a large, multi-year rally still ahead. If you are bearish on the dollar, the outlook for the yuan (and the global economy) is stable to bullish.