Yuan Looks To Fed, Chinese Investment For Direction

Fundamental Forecast for CNH: Neutral

• Dollar Hits 8 Month Low, Anticipation Will Warp Markets Wednesday
• Australian Dollar Unmoved By As-Forecast Chinese Inflation Data

The Yuan pulled back against the U.S. Dollar this past week, after it set a 7-month high the week prior. The HIBOR O/N has been falling recently and dropped to 1.8140% on Friday, indicating easing conditions in the Yuan’s liquidity in its largest offshore market. The spread between the offshore Yuan and the PBOC’s reference rate also narrowed. It has dropped to about 100 pips as of 4 pm on Friday. Looking forward, event risks from both the U.S. and China will be major drivers to the Dollar/Yuan rate.

On the U.S. side, the Fed is widely expected to raise the benchmark interest rate this coming week and this is likely already priced-in. A more important question is when and how the central bank will reduce its balance sheet; the answer will greatly impact the Dollar outlook. Currently, the USD/CNH has dropped back to below 6.7974, a level before the U.S. election. Amid the lack of movement in fiscal policy by the Trump administration, U.S. Dollar’s gains against the Yuan have been wiped out. Within such context, the Fed’s decision could become the primary factor to determine the next trend of the Dollar/Yuan rate.

While Yuan’s offshore liquidity is eased, in the onshore market, costs of borrowing the Yuan remain elevated. Since last week, 1-year SHIBOR, Shanghai Interbank Offered Rate, has exceeded both commercial banks’ Loan Prime Rate (LPR) of 4.30% and PBOC’s benchmark lending rate of 4.35%. SHIBOR measures the cost of commercial banks borrowing from each other. LPR is the loan rate that commercial banks provide to its best customers. The PBOC’s benchmark rate is the primary reference rate that the regulator uses to guide the money market. When 1-year SHIBOR surpasses 1-year LPR, a bank will suffer a loss if borrow from its peers and lend out to its best customers. This largely reduces banks’ incentive to issue credit, even to its best customers.