| Yuan Appreciation – A Market Tsunami or a Ripple on a Mill Pond? |
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| Monday, 17 May 2010 14:26 |
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There has been a great deal of speculation lately that China may make a move to ease the Yuan peg tothe US Dollar and to allow its currency to appreciate again. Political pressure from the United States, aswell as many of China’s other trading partners, has been mounting with the aim to achieve this verygoal. While it is definitely not a certainty, it does seem that with China’s large trade surplus as well asother measures they have enacted recently to temper their red-hot economy, the time may be right forfurther Yuan appreciation. If this event takes place, the natural question for traders around the world is “How will this affect the markets?
As to the question on market impact, there are many variables to consider and it is far beyond the scopeof this paper to address them all. We do have some historical guidance based on the result of the Yuanappreciation from 2005 to 2008; however, I think it is very safe to conclude that the world is a much different place now, particularly the economic landscape, and the previous results may be misleading atbest. One of the big unknowns remains, if China allows the Yuan to again appreciate, by how much andin what time frame will they do this? It is doubtful that China would simply allow a free-float anytimesoon; instead it will most likely be a sort of structured stepping peg in which the valuation changes modestly over time. Additionally, while this topic deserves trader’s attention, it is just one event in a world slammed by an economic landscape that changes by the second and so it becomes very difficult tosay with any degree of certainty what the actual impact may be. For the analysis below, I will be operating in the rare luxury of a sort of vacuum and only looking at the direct impact any valuation change may have without regard to developing situations globally. As the world rotates, events above and beyond a rising Yuan will still need to be considered before any trades are made. Commodities – In theory a stronger Yuan should lead to higher commodity prices, particularly in items related to production and manufacturing. By effectively making these goods cheaper in US Dollar terms the consumption giant that is China may create additional demand. Natural Gas (Liquified), Crude Oil, Rubber, Copper, Platinum and Palladium would stand out as some clear commodities in which demandcould increase and prices rise. To a certain extent, we have already witnessed this phenomenon in anticipation of a rising Yuan. There are a couple of counter-points to the argument of rising commodity prices though. The first beingthat while China is a huge consumer of these products, the rest of the world needs to be considered as well and with many of the world’s economies and consumers simply unable to support higher commodity prices, there is probably a more firm and logical cap than what existed in the heady, credit filled days before the economic collapse. The second factor that could potentially negate risingcommodity prices are the economic tightening policies taking place in China. These policies are designed to slow down the rapid pace of growth and keep the economy from overheating. If manufacturing andinfrastructure spending slow, the huge demand for industrial commodities may slow some as well. While it is true that the factors listed above may slow down any type of commodity appreciation, I feel we will still see some commodity appreciation if the Yuan strengthens. Even as the advanced economies demand may remain at low levels for some time and not support higher commodities prices, otheremerging markets whose competitiveness is enhanced by a stronger Yuan will help to bolster somedemand. Also, even though some degree of tightening is taking place in China, even a drop of 2% in GDPwould still represent exceptional growth and demand for resources. Also, one sector that does not appear to be slowing is the automotive sector in China. While there will likely be some consolidation of manufacturers in the Chinese automobile sector with the five-year average annual sales growth rate atnearly 23% and with the first 3 Months of 2010 representing a year-over-year growth rate of 80%demand looks to be strong particularly for Oil, Rubber, Copper, Palladium and Platinum. Even if all of the fundamentals balance each other to a stalemate, there is one more very important consideration. We always have to remember that fundamentals don’t drive markets, traders buying andselling drive markets. If traders perceive that a currency appreciation in China will move the markets higher, the markets will almost invariably move higher. US Dollar – There are a multitude of factors that have driven strength in the US Dollar since the lows of last December (2009). One of those factors is clearly the USD’s position as a safe-haven currency. With the onset of the Dubai debt crisis and then extended with the sovereign debt crisis in Greece, it is notsurprising that US Dollar denominated instruments were gaining ground. Another factor that cannot be overlooked though is demand from China’s trading partners and export competitors. With China’s pegto the USD remaining intact since 2008, the most apparent means of strengthening the Yuan was bystrengthening the Dollar. With countries such as Brazil (Real), Russia (Ruble), India (Rupee), South Korea (Won), Singapore (Dollar – SGD) and Malaysia (Ringgit) actively trying to stay price competitive with China, they were in manycases selling off (weakening) their currencies to buy greenbacks as the only recourse to strengthen a relatively weak Yuan. It is very difficult to quantify in percentage terms what type of strength in the US Dollar this action translated too; however, without the need to continue this action we could see a bit ofslack in the global demand for the US currency. While I would expect to see the currencies listed above appreciate somewhat against the Dollar, I would look for the gains to be somewhat modest and in stepwith any appreciation in the Yuan. With regard to the Euro and Pound, while there may be some Dollarsoftness, I would not expect it to translate into giant gains for either of these currencies on the premisethat there are just too many factors involved that outweigh a monetary shift by China that any gains would be somewhat restrained. If Oil prices do rise on the on speculation of future Chinese demand, in the short term I would look for the commodity related CAD to strengthen as well. In the longer term; however, this correlation seems to break down as we witnessed in late 2007/ early 2008 when Oil was climbing to new highs but the Loonie ceased to follow. Due to the close trading ties between Canada and United States there appears to be somewhat of a ceiling on the appreciation of the CAD versus the USD. US Equities – In regard to the broader equity indices the long-term change may not be noticeable. As the US continues to work its way back to an economic level that may be considered normal, situations in the housing sector and the labor force will join forces with pending US regulations to take center stagenow and well into the future. A move by China may strengthen the attractiveness toward emergingmarkets for some US investors; however, we have already seen this taking place with so far few major implications. Additionally, if the US dollar shows some softness, any outflows from domestic US funds may be compensated for by foreign investors looking to pick up US equities at a currency relative discount. Where a stronger Yuan may be felt the most will likely be in individual companies that have exposure toChina on an import or export basis. While some US manufacturers may be helped by an appreciation of the Yuan other may be hindered. If the price of industrial commodities do climb companies such as Ford(F) or Goodyear Tire (GT) may have to find a way to operate on slimmer profit margins. My guess is though, most major US companies with exposure to the commodity price fluctuations will most likelyalready be instituting a pretty tight hedge and should not suffer too badly. One company that I do feel could be the beneficiary of a stronger Chinese currency is Apple (AAPL). With a stock price that has doubled over the last twelve months the question becomes; “how can they keeptopping themselves.” Part of the answer to that question may lie in China. On the Apple earnings call onApril 20th, COO Tim Cook for the first time broke out the figures for Apple’s operations in China and theywere impressive to say the least. (As a note, on the call Mr. Cook indicated that the informationregarding China included the mainland, Hong Kong and Taiwan.) Apple has added 800 more distributors in China which is considered the fastest-growing mobile market. Revenue jumped up 200% year-over-year to $1.3 Billion and looks to continue to grow at a rapid pace. One of the bearish arguments toward Apple in China has been that the price of the iPhone is priced above the level most consumers there canafford. If the Yuan appreciates against the Dollar Apple looks to benefit by making their products less expensive which expands their already impressive audience which in turn may expand Apple’s revenue. As with any forward looking analysis, all of the speculation in this commentary is said with a greatdegree of uncertainty. Much of any market reaction to Yuan appreciation will depend on to what extent it is allowed appreciate as well as the time it takes to appreciate. In my opinion the overall marketimpact will be drawn out and the moves will be in moderation. That being said, the knee-jerk reaction toan announcement from China that they are making this move could be severe. Conversely, with so manytraders already making moves in anticipation of a gain in the value of the Yuan, if China fails to make a move or comes out with a statement that they will not be removing the current peg, the reaction couldbe just as severe in the opposite direction. On a final note, this analysis barely scratches the surface of all of the global factors impacting the markets on any given day. The intention of providing this information was not intended as a recommendation to buy or sell any instrument and should not be construed as such. Rather the aim of this analysis is to provide traders with some points to consider and to open a dialogue for furtherdiscussion on the matter. As at any point in time in any market, results or reactions are neverguaranteed and as traders our primary responsibility is to understand all of the risks involved in anytrader we place. Written by: Dan Cook Senior Market Analyst, IG Markets Chicago Georgia Anderson` Financial News Network, trader, trader education, online forex, daytrader,forex currency, forex software, investors, forex trading, forex. |
Disclaimer
There is substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products. Each investor must consider whether this is a suitable investment.
Trades or trade recommendations made on this site have not been made by Georgia Anderson.
Trades or trade recommendations made on this site have not been made by Georgia Anderson.
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