China struggles to support CNY & avoid exporting disinflation


By Ashraf Laidi, Chief Global Strategist at City Index

The People’s Bank of China is increasingly resisting traders’ weakening of the Chinese yuan, by announcing higher rate in its daily central reference rate. But as Chinese data continue to weaken across the board, FX traders have no choice but to bet against the yuan (pushing up the USD/CNY rate). 

The chart highlights the divergence between the PBOC’s falling reference rate, known as CNY fixing price as set by the China Foreign Exchange Trading System (red) and the spot rate in the interbank market, the fluctuations of which should not exceed +/- 2% of the average price.

Trade the Chinese yuan with City Index here 

Aside from signs of China’s slowdown shown in retail sales and consumer credit, last night’s release of Nov PPI contracting by 2.7% — below zero for the 13th consecutive months — and the 1.4% CPI being the lowest in five years underscores the threat that China’s hard landing story is at its most credible status since misplaced warnings have begun in 2009.

The adjacent chart highlights China’s deteriorating capital account balance, which tumbled to a negative $601 million in Q2 as a result of surging capital outflows. We patiently await the release of capital account breakdown for Q3.

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What should the Fed do? The case for opportunistic inflation

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Published on Dec 5 on The Economist.

Sometime next year, the Federal Reserve will likely face an unusual confluence of economic circumstances. One of its mandates, full employment, will call for monetary policy to tighten relatively quickly; the other, inflation, will suggest it should stay loose. How should the Fed weigh these competing goals? It may want to dust off a doctrine from the 1990s, “opportunistic disinflation” and rechristen it “opportunistic inflation.”

The impressive pace of job creation reported today underlined the approaching crunch point. The number of new non-farm jobs in November, at 321,000, was the most in nearly three years. Along with revisions of 44,000 to prior months, it shows this year’s already-solid pace is accelerating. The unemployment rate remained at 5.8%, but if this year’s combination of job and labour force growth continue, it will drop below 5% within a year, easily undershooting the Fed’s estimate of its natural rate. True, the current unemployment rate may overstate how strong the labuor market is, but other measures suggest slack is quickly disappearing: the broader U-6 measure of underemployment dropped to 11.4% in November, from 11.5%, long-term unemployment edged down to 1.8% from 1.9%, and involuntary part time work declined.

But even as the Fed hits its full-employment target, it will be badly missing on its 2% inflation target – from below. Headline inflation was 1.7% in October, and core inflation, according to the Fed’s preferred index, was just 1.5%. Petrol prices have plunged further since, so headline inflation is likely headed below 1%, and pass-through effects will likely push core further down as well.

The view inside the Fed is that this undershoot is temporary and over the next few years, a strengthening economy and inflation expectations will tug inflation back to target. They shouldn’t be so sure. The fall in the oil price is a mixed blessing. It will generate a powerful lift to consumption and employment in the next six months, and indeed may already have, given the strength of retail employment. But, along with the rise in the dollar and the fall in other commodity prices, it will keep inflation below target for several years. Inflation has already persisted below target longer than the Fed expected, and the latest data suggest that it is the public’s expectations of inflation that are converging towards actual inflation, rather than the other way around.

This makes it all the more likely that expectations, and thus actual inflation, will become entrenched below target. Against a backdrop of full employment, this may seem acceptable. It isn’t. Too-low inflation means that the next time the economy falls into recession, interest rates will once again probably fall to zero, which may be too high in real terms to adequately restore growth. The risk, then, is that inflation grinds even further below target.

While the circumstances facing the Fed may be novel, the tactical challenge is not. Two decades ago, inflation was above any reasonable definition of price stability. In contemplating how to get it lower, Fed officials came up with the moniker of “opportunistic disinflation.” The Fed would not deliberately push the economy into recession, but it would exploit the inevitable recessions and resulting output gaps that came along to nudge inflation closer to target. In 1996 then governor Laurence Meyer defined it thus:

Under this strategy, once inflation becomes modest, as today, Federal Reserve policy in the near term focuses on sustaining trend growth at full employment at the prevailing inflation rate. At this point the short-run priorities are twofold: sustaining the expansion and preventing an acceleration of inflation. This is, nevertheless, a strategy for disinflation because it takes advantage of the opportunity of inevitable recessions and potential positive supply shocks to ratchet down inflation over time.

The strategy succeeded: after the recession of 2001, inflation fell to 2% and stayed there.

Today’s mirror image would be “opportunistic inflation”: exploit any overheating in the economy as an opportunity to push inflation higher. If unemployment does fall to 5% next year, that should have two beneficial effects for the labour market. First, it should push up wages. Hourly earnings rose 0.4% in November, an unexpectedly brisk and long overdue increase. But they are still up just 2.1% from a year earlier. Since profit margins are so wide, it will take several years of stronger wage growth to generate cost-push inflation. Second, some of the long-term unemployed who have quit the labour force should be drawn back in, reversing some of the loss of potential output brought about by the prolonged period the economy spent depressed.

To get inflation higher requires a negative output gap by allowing unemployment to fall below its natural rate for a time. That may happen even on the current plan in which interest rates start to rise slowly from zero in 2015. If so, the Fed should simply let it happen. It may want to encourage the process by delaying the normalization of rates, or stretching it out over more months. This is not without pitfalls; inflation could take off more quickly than expected, or financial imbalances could worsen. On the other hand, inflation may stay dormant for longer, and the Fed will then conclude the natural rate of unemployment is actually lower than 5%; and it will have been glad not to have tightened too soon.

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Prospects of the FX markets


Interview with Greg Michalowski @GregMikeFX, chief of technical analysis and client education at ForexLive

Based on the current market situation and your personal experience in previous years, do you think there will be a year-end rally in the markets this December? How significant movement could it be?

Since I deal in the forex market, my focus will be on that market.

Typically, activity dies down but that can be a double edged sword in the forex market. Lower liquidity can lead to a market that hardly moves. It can also lead to up and down volatile moves, as traders get whipped around from the sporadic flows. As a result, if traders are going to play in the game, they have to be aware of the changing environment. Personally, it is not my favorite month. Nor do I recommend that traders in the forex market expect the month to be one of their best either.  So manage expectations and you should be ok.

Having said that, in the forex market, much is dependent on the economic data and events as well. This month the ECB interest rate decision on Thursday December 4th, followed by the US employment report on December 5th has the potential to rile the market especially in the current environment of diverging economic fundamentals.

If Draghi talks more dovishly and the US employment numbers surprise to the upside,that can ignite a continuation of a run into the US dollar and get the EURUSD moving back lower. Even so, a move to the 1.2131 area (around 300 pips) is probably the best that we can expect on the downside.  This level is the 50% of the EURUSD range since it’s inception in January 1999. It would be a nice level to trade around into the New Year.

Can the USD go lowert? I suppose so. The GBPUSD is scraping at low levels and a move to 1.6000 is possible. USDJPY reached 119.12 and could we go lower on weaker US data. That could push USDJPY toward the 115.00-116.00 area.  The AUDUSD made new year lows on December 1. The 50% of the move up from 2008 low comes in at 0.8542. A move above that level will be bullish for the AUDUSD in the short term. The EURUSD has upside resistance at 1.2660 and then 1.2746-57.  It might be a stretch to get there but illiquid markets can squeeze traders too.

Another event that will be on traders radar is the December FOMC decision scheduled for December 17th. At this meeting Chair Yellen will be holding a press conference and the members of the FOMC will be making their Central Tendency projections for GDP, Inflation and Employment. The members will also give projections for lower and upper band for rates in 2015, 2016 and beyond.  The last time the Fed did this was in mid- September. It will be curious to see how the distribution of rate forecasts come out.  I thought that the projections for 2015 were a bit too high in September. A few months hence, will the members tone down their projections for tightenings a bit?  That might be a little dollar bearish.

In your opinion, what are the best markets to operate in during the year-end rally? Have you any previous experience worth mentioning about trading in that part of the year? No real suggestions for this…..

Could you give same tips or advice for trading during the last weeks of the year? 

My advise for traders is it is okay to “fall in like” with the whatever you are trading, but try not to “fall in love” with anything.   It is probably not the time for a long term love affair with anything.

Other advise: Don’t be shy to take profits or partial profits when you have them. If you don’t feel comfortable, take a loss and finally, be patient on your entries.  Great trade entries often come from being very patient – even if you end up missing a trade or two.  The goal in December is to make what you can, don’t blow up and look forward to January.

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Dollar Reaches Two-Year High Versus Euro Before Confidence Dat

The dollar appreciated to the strongest level in two years versus the euro before reports this week economists said will show U.S. consumer confidence and retail sales improved.

A gauge of the dollar headed for its highest close in more than five years after China said imports unexpectedly fell in November, underpinning demand for the currency of the U.S. where growth is beating forecasts. The New Zealand and Australian dollars slid to the weakest levels in at least two years after the data from China, the nations’ largest trading partner. South Africa’s rand slumped to a six-year low and Russia’s ruble extended its drop versus the greenback this year to 39 percent.

“We’re seeing good fundamental support for the dollar move,” said John Hardy, the head of foreign-exchange strategy at Saxo Bank A/S in Hellerup, Denmark. “It’s not just about the currency moving higher we’re also seeing the market drastically marching forward the first anticipated Federal Reserve rate hike. Any currency where the economy is leveraged to oil is still weak. U.S. rates heading higher is a very strong negative for emerging markets.”

The dollar gained 0.2 percent to $1.2256 per euro at 10:11 a.m. London time, the strongest since August 2012, after gaining 1.4 percent last week. The U.S. currency fell 0.3 percent to 121.13 yen. The yen strengthened 0.5 percent to 148.46 per euro.

The Bloomberg Dollar Spot Index, which tracks the U.S. currency against 10 trading partners, climbed 0.1 percent to 1,123.56, set for the highest close since March 2009.

China Imports

China’s imports fell 6.7 percent, the customs administration said, compared with the median estimate among economists surveyed by Bloomberg News for a gain of 3.8 percent increase. Exports (CNFREXPY) rose 4.7 percent from a year earlier, less than the forecast for growth of 8 percent.

New Zealand’s dollar slid as much as 1.1 percent to 76.24 cents, the lowest level since June 2012. Australia’s dropped for an eighth day and touched 82.60 cents, the lowest since June 2010.

The kiwi also weakened for a second day before the Reserve Bank of New Zealand meets to review interest rates on Dec. 11.

“The New Zealand dollar is high beta to the U.S. dollar, so if the U.S. dollar rallies, the New Zealand dollar will be sold aggressively,” said Imre Speizer, a markets strategist at Westpac Banking Corp. in Auckland. “Also, we have the RBNZ this week, which will have a dovish shift from the previous forecasts in September,” he said, referring to the central bank’s policy decision on Dec. 12.

Click here to read the full article on Bloomberg


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Yen Weakens to 120 Per Dollar for First Time Since 2007

The yen weakened to 120 per dollar for the first time since July 2007, as policy makers’ decisions to expand monetary stimulus and delay a consumption tax increase highlight the risks the economy is deteriorating.

The yen has plunged 9 percent since the Bank of Japan on Oct. 31 increased the annual target for expanding the monetary base to 80 trillion yen ($667 billion), and Prime Minister Shinzo Abe delayed a second bump to the sales levy by 18 months, after the first in April sent the economy into recession. Abe is forecast to score a second landslide victory in a Dec. 14 election.

“It’s still the divergent-growth, divergent-policy story,” Robert Sinche, a global strategist at Amherst Pierpont Securities LLC in StamfordConnecticut, said by phone. “We are seeing capital flows out of Japan, and I think that helps bring capital out and continues this movement down in the yen.”

Japan’s currency fell to as low as 120.17 against the dollar before trading at 119.88 as of 10:02 a.m. New York time, down 0.1 percent.

The yen has been trading between 117 and 120 per dollar for almost three weeks, as traders trying to push the yen weaker ran into a wall of options centered around the price.

Options Obstacle

There were $3.01 billion of over-the-counter foreign-exchange options on the dollar-yen with a strike price of 120 that expired at 10 a.m. New York time, according to Depository Trust Clearing Corp. data tracked by Bloomberg. The strike price is the exchange rate at which call option holders can buy the underlying currency and put owners can sell.

Some options contain so-called barriers, causing the contract to either expire or to be activated if the pre-set exchange-rate level is reached. These types of contracts can also cause traders to attempt to push a currency through or away from barrier triggers. The barriers are often used as they reduce the cost of the strategy because they decrease the odds the options will be profitable.

The unprecedented stimulus by the Bank of Japan contrasts with the Federal Reserve’s discussion about raising interest rates as the world’s biggest economy strengthens, prompting further weakness in the yen. The Japanese currency will slide to 124 per dollar by the end of 2015, according to the median estimate of analysts in a Bloomberg survey.


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