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Volatility in Sight as Yuan Breaches Key 7 Level

5 August 2019Currencies

USDCNY spot onshore has pushed past 7 this morning following the USDCNY 9.15am fixing that was allowed beyond 6.90, a level that was held so far this year. 7.00 is a key psychological level and a breach is likely to raise anxiety over further complicating US-China talks and weighing on broader risk appetite.

This decision to unleash USDCNY is likely in response to the abrupt blow to the US-China tariff truce late last week when US President Trump announced 10% tariffs on remaining US$300bn of China's exports to the US.

The move has seen a sharp pick up in market volatility with losses seen in Asian equity indices while sovereign fixed income (US Treasuries) and safe haven currencies (JPY, CHF and Gold) have found a solid bid.

RMB breaking 7.00 also signals greater risk that RMB could be used as a tool for retaliation and risking further complicating US-China talks particularly as US authorities have been sensitive to currency moves. They have on multiple occasions blamed currency manipulation to dampen the impact of trade tariffs and have insisted on currency stability as an important part of any agreement between the US and China.

This move now also risks more capital outflow pressure and reduced portfolio inflows into China as onshore corporates and individuals have greater incentive to buy foreign currency and send money out, despite the likely tighter capital controls. The PBoC is also likely to consume more FX reserves to control the pace of depreciation, given the likely much stronger topside USDCNY and USDCNH demand both onshore and offshore.

Well behaved and stable price action of CNY/CNH for most of this year served as an important anchor for EM Asia FX during times of risk-aversion and USD strength. With this break higher in USDCNY, EM Asia FX has lost this anchor, and subsequent risk aversion may see Asian (and commodity) currencies weakening further while the key beneficiaries remain the safe havens (JPY, Gold and CHF).

Moreover, policy makers in several Asian countries may also be wary to committing too many resources to intervention in a broad risk aversion move, driving the local currencies weak across the board.

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