China: Sharp strengthening of CNH likely temporary - Nomura

Research Team at Nomura lists down some reasons for CNH’s sharp rally versus USD since 4 January.

Key Quotes

“First, is the significant tightening of CNH liquidity with overnight CNH HIBOR fixing at 38.3% (or the highest level since January 2016) from 7.5% a week ago. This has triggered an unwind of long USD/CNH positions with our perception and discussions with market participants that from a scaling -5 to +5 (+ being long USDs), fast money has moved from around +3 at the end of December 2016 to around +1 currently.”

“Second, is that along with FX intervention in the spot/FX forward markets, the USD/CNY fixings have also been significantly capped and especially recently, where 6.95 had been held relatively aggressively. We note that the recent largest daily errors emerged on 15 November (-100pips below our model), with the recent large negative errors being -216pips on 19 December, and -133pips on 4 January. Indeed, since 15 November, 29 out of 37 sessions have seen negative errors (averaging -41pips).”

“Third, is the recent actions and potential actions from the government to support RMB, including reports that residents are facing increased restrictions on FX purchases (Bloomberg, 3 January 2017) and that China may consider asking state-owned enterprises (SOEs) to convert foreign currency into yuan temporarily (Bloomberg, 4 January 2017). Note that exports by SOEs totalled USD242bn (10.7% of total exports) in 2015.”

“We believe these are the main factors that have led to the sharp strengthening of CNH (vs. USD) since 4 January. As there could still be some risk of a further positioning squeeze with high funding costs and potential residual long USD/CNH positions in the market, we have decided to temporarily hedge out our long USD/CNH risk with a 1W 6.86 USD put / CNH call option. That said, we are not convinced that this CNH strength represents a change in the trend of RMB weakening. Indeed, stepping back and questioning whether there have been any positive RMB developments, we struggle to find them.”