Unwavering CNY
Our event studies from the 2018-2019 trade war point towards CNY depreciation after affirmative announcements of tariff increases. However, what we have observed this time around is that Chinese authorities have kept the CNY fixing stable at around 7.17, despite two rounds of tariff increases on China. As highlighted previously, Chinese policymakers have several policy tools at their disposal including fiscal, monetary, housing, credit and FX to offset the potential growth hit from tariffs.
And judging by the FX policy reaction function so far (or lack thereof), it appears the PBoC may be less willing to use FX weakness, at least at this juncture, when the US tariff policy remains fluid. Moreover, keeping the FX stable offers the PBOC more policy options later, in case of further tariffs ahead.
This stability in the CNY meant that the investors (we met) have largely reduced their long USD/CNH positions (at least compared to pre-inauguration levels) and are now more open to more two-way risk for USD/CNH given the developments in Europe, which could offer support for the EUR, whilst being negative for the USD (if there is a rotation of funds from the US to the EU).
More open to two-way risk for USD/Asia
Coming into the year the narrative was very focused on “tariff trades”, or which Asian currencies would be most vulnerable to US exceptionalism and sluggish growth in China. On rates, even though Asian central banks have expressed preference to normalize rates, the reluctance to ease emanated from concerns around currency weakness, particularly in the event of tariffs. The narrative shift over the past week, has opened the discussion to two-way risk for USD/Asia.
Prior to the Germany budget announcement, some investors we met were already beginning to think that if USD/CNY remain stable, then there are limitations to how much low-yield USD/Asia (KRW, TWD, SGD, MYR and THB) could move higher, given their sensitivities to USD/CNY. Post Germany budget announcement, there was growing discussion around which Asian currencies could rally the most in a USD downside environment.
From our conversations with investors, the KRW appeared to be the favored expression in a USD downside scenario. The market was likely long USD/KRW going into December on “tariff trades.” Some of this positioning would have likely been reduced following its underperformance in December (driven by political instability post martial law). We have advocated being bullish KRW tactically earlier this year (via our short THB/KRW trade), however, we do not think bullish KRW is a widely held consensus view yet.
