Dollar Consolidates, While Market Shrugs Off China Downgrade

After staging a modest recovery in North America yesterday afternoon, the greenback is consolidating in narrow ranges. Momentum traders, who appeared to dominate activity recently, paused. To be sure, the greenbacks upticks have been modest, and little technical damage has been inflicting on the major foreign currencies.  

The main development today was Moody’s decision to cut China’s credit rating to A1 from Aa3. It cited the risk of a material rise in economy-wide debt levels as the economy slows. The outlook was shifted to stable from negative. It is Moody’s first downgrade of China since 1989. S&P, which has China on a negative outlook, rates it AA-, while Fitch sees it as A+.  

The impact was marginal. In part, this is due to the exaggeration of the internationalization of China. Specifically, China’s external debt is low at around 12% of GDP. The PBOC estimates that foreign investors own about CNY830 bln (~$121 bln) of mainland bonds at the end of March, compared with CNY853 bln at the end of 2016. That is equivalent to about 1.5% of the CNY63.7 trillion outstanding.  

Chinese shares initially weakened but recovered and closed fractionally higher. The price of industrial metals fell, but it is difficult to say the downgrade was the spur. Iron ore fell 4%, for example, after falling 3% yesterday. Nickel fell 1.7%, while copper slipped 1%. Among the currencies, the Australian dollar and the Malaysian ringgit seemed to be the most sensitive, but both recovered fully. 

There are three events in North America that are noteworthy: the Bank of Canada meeting, the Congressional Budget Office scoring the health care reform that already passed the House of Representatives, and the FOMC minutes.  

The Bank of Canada will leave rates on hold. The economy has generally evolved as it has expected. However, there is little reason to abandon its cautious posture. The risks from trade are significant. NAFTA negotiations begin in a few months. Although the White House has balked at the border adjustment tax, the vacuous of the Administration’s budget gives breathing space to the ongoing efforts in Congress to keep it alive. The Canadian economy has accelerated faster than the US, but the output gap is only slowly closing, and a rate hike seems unlikely over the next few quarters, at least.