Goldman Sachs Says Yen Shows Significant Value as A Recession Hedge

Views the yuan will drop further are gaining ground as signs emerge that China's central bank is preparing interest rates cuts to prop up a faltering economy.

The yuan has sharply weakened in recent weeks as China's economy slowed due to its zero-COVID lockdowns and as interest rates start rising in the U.S. The currency slid 5% since mid-April, touching 6.74 yuan per dollar in the Shanghai market on Tuesday, an 18-month low.

Furthermore, the country's central bank, the People's Bank of China, has set the yuan's reference rate in the weaker direction for three consecutive sessions through Tuesday, demonstrating it will tolerate the currency depreciating by a certain amount.

But the yuan may weaken even more. The PBOC appears to be laying groundwork for a rate cut now that it is urging commercial banks to cut deposit rates.

Last month, the Industrial and Commercial Bank of China, a major state-owned lender, cut two- and three-year deposit rates by 10 basis points to 2.6% and 3.25% for large accounts.

The weighted average rate for all new deposits nationwide stood at 2.37% for the period between April 25 and May 1, according to a report released Monday by the central bank, marking a 0.1-point drop from the previous week.

These cuts were triggered by the PBOC, which has urged commercial banks to lower deposit rates. Although nonbinding, a central bank's report issued on Monday offered incentives to lower deposit rates. Banks that fall in line will score points in macro prudential assessments, which evaluate lender health to maintain stability in the financial system.

The Chinese economy, which has slowed down largely due to Shanghai's COVID lockdown that began at the end of March, needs a shot in the arm. The restrictions disrupted logistics, and domestic demand has slumped.

The central bank aims to prop up the economy by boosting bank financing. By first lowering deposit rates, commercial banks lower their costs, creating a better environment for lending.

On April 25, the PBOC lowered the reserve requirement ratio for commercial banks by 0.25 to 0.5 percentage points, a move that also lowers costs for banks. It was the first time the reserve ratio has been cut since December, and the average rate for all banks fell to 8.1%, a low not seen since July 2006.

In addition, the central bank has returned 800 billion yuan ($119 billion) in profit to the central government this year, money that will be directed to companies and other entities, meaning the same amount of money is being supplied to the market. This would be equivalent to lowering the reserve ratio by 0.4 point, according to the PBOC.

After noting these cost-cutting measures for banks, many in the market believe that the PBOC is setting the stage to cut the loan prime rate, which functions as China's de facto policy rate.

"A rate cut will occur in May or June," said Lu Ting, chief China economist for Japanese brokerage Nomura Holdings.

One lingering concern is the risk that a sharply weaker yuan will trigger capital flight. If China goes in the reverse direction of the rate hikes taking place in the U.S. and Europe, it may create pressure on international investors to sell off Chinese government bonds and other assets. It is believed that the PBOC is monitoring the yuan's movement closely in the run-up to its monetary decision.

The turbulence in global markets is throwing a lot of mixed signals, but there's one that everyone is agreeing on: this is a very bullish time for the U.S. dollar.

Goldman Sachs Group Inc., Morgan Stanley, JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp. and Societe Generale SA are all telling clients that as long as fear runs through markets, the U.S. currency will keep charging higher.

"There's no other alternative," said Kit Juckes, chief FX strategist at Societe Generale. "If we get one big single bad event in the world, or a big big fall in equities, or a geopolitical event, the dollar will spike higher, so certainly nobody wants to be short of it."

The clamor for the safest of safe havens, the Federal Reserve's aggressive rate hikes and global shocks from the war in Ukraine and China lockdowns are all driving more cash into the dollar.

It's a market force that will raise the buying power of Americans facing inflation, but also make exports less attractive. The stronger dollar will tighten financial conditions at a time when many economists are warning about the prospect for a recession.

The Bloomberg Dollar Spot Index has surged 5.4% since the start of April and near the strongest levels on record. The currency is at US$1.05 against the euro and more analysts have started raising the possibility that the two could soon trade at parity.

More money is being concentrated in dollars as a result of the selloff in stocks and bonds, said Kamakshya Trivedi, the co-head of global FX and interest rates at Goldman Sachs. The bank estimates that investors have sold US$65 billion in stock and bond funds over the past month, the first major outflows since the pandemic chaos of early 2020. On top of that, flow data show that demand for major currencies is contracting.

Some strategists are starting to add caution that the dollar is looking overvalued. The currency is the most expensive in the G-10 based on real effective exchange rates, according to the Bank of International Settlements.

"Positioning is increasingly tilting towards the long USD trade," said Jeremy Gatto, a portfolio manager on Unigestion's cross asset solution's team. "Momentum is bound to slow."

The dollar hovered near a two-decade high against major peers on Wednesday, ahead of a key reading on inflation that should provide clues on how aggressive the Federal Reserve will be in tightening monetary policy.

The dollar index, which measures the currency versus six rivals, was around flat at 103.92, not far from the high of 104.49 reached at the start of the week for the first time since December 2002.

The euro languished at 1.05305, continuing to trade mostly sideways since plumbing a more than five-year low at 1.04695 at the end of last month.

The yen continued to get some respite from a pause in the recent relentless rise in benchmark U.S. Treasury yields, trading little changed at 130.40 per dollar, after dipping to a more than two-decade low of 131.35 on Monday.

Investors will be closely watching the April U.S. consumer price index reading later on Wednesday for any signs inflation may be starting to cool, with expectations calling for a 8.1% annual increase compared with an 8.5% rise recorded in March.

After the Fed raised its benchmark overnight interest rate by 50 basis points last week, the largest hike in 22 years, investors have been attempting to assess how aggressive the central bank will be.

Markets are priced for another hike of at least 50 basis points at the central bank's June meeting, according to CME's FedWatch Tool.

The greenback has climbed nearly 9% this year amid an increasingly hawkish Fed, as inflation burned hotter than policymakers had expected.

Commonwealth Bank of Australia sees the risk tilted to further gains from here.

"The USD's reaction to the CPI will be asymmetrical in our view," CBA currency strategist Joseph Capurso wrote in a client note.

"A positive surprise will encourage markets to increase pricing for a 75 (basis point) increase in the Funds rate later in the year and support the USD, while a negative surprise will keep pricing for 50bp increases in June and July intact and leave the USD steady."

The euro "remains heavy" above $1.05, he wrote, and a strong CPI print could push the Australian dollar below $0.69.

The Aussie ticked up 0.17% to $0.6951 on Wednesday, but not bouncing much from the 22-month trough of $0.6911 touched on Monday.

Sterling also struggled near a 22-month low at $1.2262 from the start of the week, last trading flat at $1.2323.

Bitcoin nursed its wounds after dropping to the cusp of $30,000 this week for the first time since July of last year, changing hands at $30,758.92.

1. Xi Jinping speaks with Macron: Vigilance against bloc confrontation, which poses a bigger and more persistent threat.

2. China's Foreign Ministry: The U.S. revision of the "fact sheet of U.S.-Taiwan relations" will surely invite trouble.

3. Yoon Suk-yeol takes office as South Korea's new president, and his internal and external policies may be totally different from Moon Jae-in's five-year legacy.

4. Google is again hit by an antitrust lawsuit: dating-app giant suing Google over "in-app payment".

Chinese President Xi Jinping spoke by phone with French President Emmanuel Macron on the afternoon of May 10.

Over the past five years, Mr. President and I have maintained close contact, leading China-France relations to keep a positive development momentum, promoting bilateral cooperation to achieve fruitful results, and showing a sense of responsibility as major countries in addressing climate change and protecting biodiversity, and other issues, Xi said, according to Xinhua News Agency. In the face of the world's unprecedented changes in a century, China and France, as permanent members of the UN Security Council and independent powers, should adhere to the original intention of establishing diplomatic relations of "independence, mutual understanding, far-sightedness, mutual benefit, and win-win situation", adhere to the positioning of a close and lasting comprehensive strategic partnership, respect each other's core interests and major concerns, and coordinate and cooperate closely at bilateral, Sino-European, and global levels. China is willing to continue to work closely with the French side at all levels to promote the healthy development of Sino-French relations and maintain world peace and stability.

In response to a recent revision of the "fact sheet of U.S.-Taiwan relations" by the U.S. Department of State, Chinese Foreign Ministry spokesman Zhao Lijian said on May 10 that such Political manoeuvres on the Taiwan issue and attempts to change the status quo in the Taiwan Strait will surely invite trouble.

The inauguration ceremony of South Korea's new president was held in front of South Korea's National Assembly building in Yeouido, Seoul on the morning of May 10. Yoon Suk-yeol, aged 61, the conservative candidate who won the election in March this year, was sworn in as the 20th president of South Korea. The new South Korean president, a former Prosecutor General who was elected by the conservative party, faces the challenges of governing with the growing tensions on the peninsula, the ongoing stalemate and potential escalation of the Russia-Ukraine conflict, the risks of global supply chains, and inflation, as well as the highly torn ideological confrontation within South Korean.

The dating-app Tinder under the U.S. dating-app giant Match Group is known as the world's most popular dating app.

09:30 China CPI YoY (Apr)

09:30 China PPI YoY (Apr)

14:00 Germany CPI Final YoY (Apr)

16:00 China Social Financing Scale (Apr)

--China M2 Money Supply YoY (Apr)

20:30 U.S. CPI YoY (Not SA) (Apr)

--U.S. Core CPI YoY (Not SA) (Apr)

22:30 U.S. EIA Crude Stocks Changes for the Week Ended May 6

--U.S. EIA Gasoline Stocks changes for the Week Ended May 6

--U.S. EIA Refined Oil Stocks Changes for the Week Ended May 6

22:30 U.S. EIA Weekly Crude Oil Imports for the Week Ended May 6

Asian equity markets are set to open lower following a seesaw session in the US stocks overnight. Wall Street curtailed early gains and finished mixed ahead of the key CPI data due for release tomorrow. Tech stocks rebounded on dip-buys. The Fed officials reaffirmed the roadmap of a 50-basis points rate hike in the next few meetings and believe the economy is in a good shape to take higher rates. However, the broader sentiment is too fragile to recover from a cloudy economic outlook. Inflation is widely expected to be moderated in April, but any disappointing figure could trigger a further selloff in the risk assets.

Global headwinds continue to pressure the regions' stock markets. Rising rates and China's slowing growth are the major factors that weigh on sentiment.

SPI futures slid 0.11%, pointing to a lower open in the ASX. The NZX 50 was up 0.09% at the open but suffered from the global equity's selloff the last two trading days, finishing at 11,229.45 on Tuesday, the lowest seen since June 2020.

Company Earnings:

Pushpay FY earnings were reported at US$62.4 million, in line with expectations. Customer number increased by 31%, to 14, 508. Operating revenue grew 13%, to US$202.8 million. The company expects double-digit revenue growth in FY23 and strong FY24 growth. Its shares dropped 2.24%, to NZ$1.31 at the NAZX open.

The key events and data today:

Australian Westpac consumer sentiment – 10:30 am EAST

Spark is seeking indicative bids for as much as 70% of its mobile phone tower business - AFR

The broader markets cut early gains as the tech-led rebounding lost steam at the close. Nasdaq lost 25% year to date, officially falling into a bear market. S&P 500 finished flat at 4,000 after hitting the fresh year low at 3,957.

Dow (-0.27%), S&P 500 (+0.25%), Nasdaq (0.98%)

Biggest Winners:

Technology (+1.62%), Communication services (0.9%), Energy (0.93%)Mega-caps rebounded on dip-buys.

Apple (+1.52%), Microsoft (+1.81%), Alphabet (+1.61), Meta Platforms Inc. (+ 0.66%), Amazon (+0.05%), Netflix Inc (+2.61) Tesla (+1.6%), Nvidia (+3.73%). Biggest losers:  

Utilities (-1.25%), Financials (- 0.74%), Consumer Staples (-0.76%)

Major banks fell due to weak economic outlooks.

JPMorgan Chase (-2.44%), Wells Fargo (-2.02%), Citigroup (-2.34%), Goldman Sachs (-1.28%)

Company earnings:

Peloton slid 9% on widened losses and weak guidance. The company lost US$2.27 per share vs. -US$0.83 expected. Revenue is at US$964.3 million, short of the expectation of US$972.9.

Coinbase shares tumbled 10% in the after-hours trading on a net loss of US$430 million. The crypto exchange guides for lower trading volume in the second quarter.

The Europe major indices closed higher along with the early US equities' positive turnaround.

The Stoxx 50 (+0.97%), FTSE 100 (+0 37%), DAX (+1.15%), CAC 40 (+0.51%).

Crude oil prices fell for the second trading day on China's growth concerns and the broader risk-off sentiment. The WTI futures fell under the $100-mark.

WTI: $99.44 (-3.23%), Brent: $102.16 (3.26%), Natural Gas: $7.30 (+5.11%)

Precious metals continue to slide on a strong USD.

Spot Gold: $1,838.44 (-0.85%), Spot Silver: $21.27 (-0.53%)

Algaculture commodities were slightly up.

Wheat: $1,092 (+0.00%), Soybean: $1,592 (+0.44%), Corn: $775.25 (+0.42%).

USD strengthened, while commodity currencies fell further on moderating export prices.

US dollar index: 103.935 (+0.24%)

EUR/USD: 1.0528 (-0.28%)

USD/JPY: 130.44 (-0.10%)

USD/CAD: 1.3029(+0.15%)

AUD/USD: 0.6939 (-0.17%)

NZD/USD: 0.6290 (-0.65%)

US 10-year: 2.99%, US 2-year: 2.60%.

Germany bund 10-year: 0.99%, UK gilt 10-year: 1.85%.

Australia 10-year: 3.56%, NZ 10-year: 3.78%.

The Crypto markets cut early gains and finished lower. The whole market cap was down 1.56%, to US$1.41 trillion.

Bitcoin: $30,852 (-1.45%)

Ethereum: $2,305 (-0.25%)

The global currency has entered a comparison weaker mode. After entering the end of April, the exchange rate of CNY against the USD has experienced a rapid depreciation process, calculated at the spot exchange rate, the depreciation reached 3.3% in the last 10 trading days of April, which not only ended the appreciation process since the second half of 2020 but also erased the appreciation results of the past five quarters. However, the author believes that the medium and long-term trend of the CNY has not changed, the 2-week exchange rate "diving" market is just a small "splash" in the process of the CNY exchange rate, and the process of CNY appreciation is not over yet. After the meeting of the Political Bureau of the Central Committee of the People's Republic of China to restore market confidence, with the gradual formation of Shanghai's "unblocking", the CNY exchange rate will return to the balance zone (6.3-6.4).

For the CNY exchange rate, the market is most concerned about the exchange rate of CNY against the USD. The CNY /USD exchange rate has become the "benchmark" exchange rate because of habit, and the other because of the importance of the USD; The USD is the most important international currency in the global monetary system. Whether it is in the fields of trade, investment, or reserves, no matter which indicator is used, the proportion of the USD is around 70%. Therefore, changes in the exchange rate of CNY against the USD naturally affect the "nerve" of the market. However, the market panorama of the change in the CNY exchange rate this time is that, apart from a sharp depreciation against the USD, the CNY has been relatively stable against other currencies. The exchange rate movements of the currencies were: 1.0% against the EUR, 0.4% against the GBP, and 1.9% against the JYP.

From the map of changes in the global foreign exchange market, the sharp depreciation of the CNY against the USD occurred against the background of the appreciation of the USD. In terms of the time course, the strength of the USD has already started as early as the second half of 2021. Expectations of a reversal of Fed policy are the basis for the USD to enter a strong course. After the second half of 2021, the market began to brew the Fed's "taper" and interest rate hike expectations; with the gradual rise of inflation in Europe and the United States, market expectations for the reversal of Western monetary policy have gradually strengthened. Although the Western monetary authorities are trying their best to eliminate such expectations in the market throughout the process of 2021, they continue to express official judgments such as inflation being temporary and not sustainable.

Therefore, the strong process of USD has already started, which is based on the withdrawal trend of Western monetary policy. Why does the USD stand out under the expectation of the overall withdrawal of the loose monetary policy in the West? As far as the six major central banks in the West are concerned, the United States is not the first to raise interest rates. The United Kingdom started the process of raising interest rates as early as December 2021. However, the exchange rate of GBP/USD remains weak. The inherent understanding in the international currency market - there is a tradition among Western central banks to follow the actions of the Federal Reserve, and the market believes that the global economy has not yet come out of the shadow of the 2008 crisis, there is an underlying perception that the growth rate is still low, making the USD's position in the international currency field still strong. Most importantly, the hegemony of the USD in the international monetary field remains unshakable.

After the outbreak of the Russian-Ukrainian war, affected by geopolitical factors, the USD became more and more powerful, which was manifested in the exchange rate market, and the appreciation of the USD against non-US currencies accelerated. Judging from the change in the exchange rate of USD against the currencies of major non-US countries, the time of the Russian-Ukrainian war is the demarcation point for the acceleration of the appreciation of the USD. From January to April 2022, the monthly exchange rate changes in each month are (%): JYP, 0, 0.1, 5.8, 6.7; EUR, 0.9, 0, 0.8, 5.7; GBP, 0.7, 0, 2.3, 4.8. The USD has become strong, which is conducive to the current United States tightening monetary policy to fight domestic inflation - the capital inflow attracted by the strong USD will help maintain capital markets' stability without having a direct expansionary effect on aggregate demand in the real sector. Therefore, there are many market views that the United States welcomes the evolution of the Russian-Ukrainian conflict into a hot war because it is in the economic interests of the United States! Regardless of the motivation behind it, after the outbreak of the Russian-Ukrainian war, USD has indeed experienced a process of accelerated appreciation.

Before April 18, CNY has been stable. Although USD has been strong since the second half of 2021, the appreciation process of CNY started earlier than USD 1 year. When USD started the appreciation process in the second half of 2021, the appreciation process of CNY has been started for more than a year. From July 2021 to March 2022, the international currency market showed a trend of strengthening the currencies of China and the United States. After 2022, the strength of the USD has become more and more obvious, but CNY still maintains a steady upward trend, so the market once believed that CNY has become a safe-haven currency. At that time, the market generally believed that even if the Fed's policy started the process of raising interest rates. However, the trend of the world's economic center of gravity shifting to China remains unchanged, and the general direction of the appreciation of CNY remains unchanged under the internationalization of CNY.

At the end of February 2022, CNY/USD was close to 6.30. Although it rebounded slightly in March, it immediately entered a balanced operation area. After mid-March, the CNY/USD exchange rate continued to run smoothly in a narrow range of (6.35, and 6.40) for January. There is more than that until April 18, when the supplement or diving mode of the CNY/USD exchange rate is turned on. Combining the time point and the relevant process during the period, China's economy is affected by the pandemic impact of market expectations, which is an important reason for the sudden stall of the CNY/USD exchange rate. On March 28, Shanghai closed the city. After April, the economic impact of Shanghai’s closure gradually emerged, and the market’s worries about the impact on the economy gradually increased. In addition, the economic data for the first quarter, which started well, was weaker than expected. The market's expectations of China's economic prospects have turned, thus breaking the smooth process of the CNY/USD exchange rate.

Exchange rate changes are an evolutionary reflection of the combined influence of political, economic, financial, and other factors. If we only consider the interest rate parity relationship in the international financial market (the most basic analysis model of interest rate changes in the international foreign exchange market), then this round of USD strength will not exist - from the perspective of time, GBP will raise interest rates earlier than USD; From a policy perspective, EUR is also facing policy tightening. For CNY whose capital account is still regulated, the interest rate parity model is not applicable, so the change in the interest rate difference between China and the United States cannot explain the recent changes in the CNY exchange rate.

From the perspective of relative changes in inflation, both Europe and the United States are facing inflationary pressures. From the perspective of the magnitude and persistence of inflation, the United States has a higher degree of inflation and stronger persistence expectations. In March 2022, the CPIs of the United States, Europe, and Japan were 8.5, 7.4, and 1.2. From the perspective of the inflation process, the United States entered high inflation earlier. From May 2021, the United States CPI entered above 5.0, while the same level in Europe was in December 2021. Inflation differences are not the main reason for this round of USD strength.

Although from the perspective of national interests, the rise in commodities caused by the Russian-Ukrainian war has benefited the United States (selling more resources at high prices) and hurt Europe (need to spend more money to import resources), the impact on the United States and European economies is in the same direction of. In addition, judging from the worse trend of JYP, traditional safe-haven currencies have not shown the characteristics of "risk-off" in the current international turmoil. From the perspective of the economic process, it is an indisputable fact that the Western world has not yet emerged from the shadow of the 2008 global financial crisis; the pandemic that has lasted for more than 2 years has not ended, and its damage to the kinetic energy of economic development has not yet been considered by people from all walks of life; overlaid with geopolitical influences such as the Russian-Ukrainian conflict, the cracks in the world economy may permanently expand, and the global supply chain system will be impacted, all countries have to seriously consider the restructuring of the industrial chain in the process of economic recovery, which in turn has intensified the "decoupling"! The economies of all countries are facing difficulties in growth and recovery, which makes the trend of currency exchange rates in various countries less consider policy and market-level factors and rely on the importance of economic growth prospects. However, under the realistic scenario that all countries have difficulties, the exchange rate movements of various countries do not reflect the improvement of a country's economy but are relatively good in comparison with other countries.

Since 2020, China's success in the prevention and control of the pandemic has created a leading position in China's economy in the global economy, and the RMB has entered a stage of continuous appreciation; During the same period, the changes in the Western monetary system entered the stage of "pulling out the generals from the weaker", and the currencies of relatively less bad economies won out, but the currency (i.e. USD) still had no advantage over CNY.

This advantage of CNY will not stop abruptly after late April. The impact of the Shanghai pandemic has made the market believe that the epidemic situation at home and abroad will be reversed. The advantages of the Chinese economy due to the pandemic will be lost and may also be turned into disadvantages. The first-quarter data has strengthened this expectation. Shanghai during the lockdown period played a subtle role in lowering China's economic prospects. The "three killings" of stocks, bonds, and foreign exchange indicate the sudden deterioration of the market's confidence in the economic outlook.

However, as the epidemic prevention policy persists until the dawn of victory, society is already preparing for a full-scale resumption of work. The focus on the impact of the pandemic has turned to the post-pandemic work resumption normalized management mechanism. A meeting of the Politburo of the Communist Party of China Central Committee on April 28 strengthened confidence in the recovery of the market. The revision of the excessively pessimistic outlook for China's economy will allow the CNY exchange rate to reverse and slowly advance toward the original balance area.

Article source: FT Chinese Website