USD/CNY: A look back onto a year of America’s many firsts, and forward to a tumultuous year ahead

While midterm results have had the Trump administration unsure of the prospects of what Trump would call a winning streak, what they can be sure about, however, is fruits of what has been a year full of hawkish economic and trade policies – 4% Q2 GDP growth, first time in four years, record low unemployment, and 6-year high corporate earnings. With the USD index (DXY) rebounding 9% from its early year low, and a growing US-China trade rift, with the US being the ones tying the hands of Chinese trade, the USD/CNY has rallied a staggering 5.04% over 12 months (As of 30 Nov 2018). Questions of times ahead, however, cast a cloud over the longevity of a heating economy and relative strengthening of the USD – specifically questions of an impending resolution or non-resolution of trade tensions, incoming rate hikes amidst inflation scare, growing geopolitical risk as it relates to oil, and possible PBoC intervention.

The G20 summit in Argentina is only days away and marking what is possibly a pivotal moment in deciding U.S.-China trade prospects of the coming months. This is especially significant as it relates to the approaching January deadline for a 15% raise on existing tariff on Chinese imports of over $200 billion value, which is set to go ahead should the Chinese government not provide some forms of concession. A positive outcome, combined with a rate hikes seemingly approaching a halt, could provide a boost in risk appetite and could see flows out of the dollar into risk assets, taking away some of the traction USD/CNY has been seeing. A negative outcome, meanwhile, could better the USD foothold as demand for haven assets are likely to pick up considerably, given the view of USD as number-one choice above CHF and JPY, and spell trouble for the CNY as trade takes a dive. Regardless of the outcome, however, it is likely that trade tensions aren’t likely to dissipate any time soon beyond the G20, so it seems the USD are secured a firm footing for a foreseeable period going forward, cementing its place as top performer of 2018 so far.

Harking back to the days of allegations of dirty floats against the People’s Bank of China for uncompetitive Yuan devaluation in 2015, it isn’t a stretch to consider the possibility of a similar course of action especially as a support system for the Chinese economy amidst looming, worsening trade outlook. Evidently, the speeding up of Yuan depreciation, 1.56% up from 0.55%, from October to September, is perhaps artefact of intervention on PBoC’s part, either through intentional means or by allowing the Yuan to naturally slide on market news. Given that a weak Yuan be looked favourable upon, should trade take turns for the worse, it is reason enough to suggest a devaluing is welcomed in helping to offset its effect in part trade dips. To be wary of capital outflows and the adversity of a weak Yuan, however, a target range for the PBoC could be limited to within the 7.0-7.1 range.

A key catalyst behind the past 12M USD rally has been the fed hikes, with the fourth time approaching in December, as of recent release. This came amidst a year and world of unchanging rates, with Europe on edge with Brexit talks and overall weak activity, showing contraction trends. This leaves U.S. rates at a relative height as compared to its developed, foreign counterparts, leading to influx of hot money giving good support to the USD throughout the year. However, rhetoric on 2019 has become more confirmative of slowing hikes, with expectations declining from 52 to 47 basis points. Therefore, a frequent rate-backed USD strengthening, as seen this year, isn’t a likely prospect going forward in 2019.

Oil has taken a deep dive despite earlier signals of above $100 recovery. Now that it sits almost below $50 per barrel, it spells for businesses and consumers what Trump has called tantamount to a tax cut. Relieving of inflationary pressure from the supply side also feeds into slowing of Fed hikes, as seen. Prices going forward also hinges on the G20 as output cuts are favoured upon by net exporters Saudi Arabia and Russia, with the U.S. opposing it. Cheaper oil could also boost industrial profitability in China, providing support to recent, slightly slowed growth pace. All in all, cheaper oil could spell a more moderate USD/CNY going forward.

In my view, the USD uptrend is set to last until Q1 2019, during which a long in USD/CNY is a recommended position. Owing to strong tailwinds of rate hikes that is evidently a key catalyst that has lasted year round and expected to continue with the onset of December rate hikes before coming to a slow in early 2019. An overall gloomy risk appetite of a slowed global growth, Brexit, and other geopolitical risk going forward in 2019 is due to support the USD as risk haven demand picks up, offsetting short-term fluctuations of looming trade outcomes. No signs from the PBoC indicate a strong desire to reverse a weakening Yuan is also looks favourable on the position.