Feedback Loop Phenomenon

In Summary

• This feedback loop has been largely a positive one for the last two decades. With the Yuan now in retreat [and in a precise response to Trump], this will surely exert serious downside pressure on those countries in the Feedback Loop. 

U.S. President Donald Trump waves during joint statements with China's President Xi Jinping at the Great Hall of the People in Beijing, China, on November 9, 2017.
U.S. President Donald Trump waves during joint statements with China's President Xi Jinping at the Great Hall of the People in Beijing, China, on November 9, 2017.
Image: REUTERS

Last Monday I wrote 

''The most important currency to watch right now is the USDCNH [and] It could slice through 7.00 like a hot knife through Butter. 

The Offshore USDCNH market popped through 7 on Monday [sending a shiver through Global markets - The Markets emit signals and the signal the market was emitting was that there was a precise correlation coefficient between a weaker Yuan and weaker S&P 500 Futures] and closed on Friday at 7.0985. On Thursday, China set its yuan fixing [onshore] weaker than 7 for the first time since 2008.

 

President Trump finally pulled the Trigger on citing China as a currency manipulator. 

"We're in that bizarro world where you can be a currency manipulator if you fail to manipulate your currency'' tweeted @TonyFratto.

It is clear that the Chinese have been keeping the Renminbi [Yuan] artificially high. 

George Magnus writing in Bloomberg's Quint 

China allowing the yuan to slide below 7 to the dollar is a watershed moment for currency markets that's symbolically equivalent to the U.S. and other countries abandoning the gold standard in the interwar period, or the collapse of the postwar Bretton Woods system of fixed exchange rates four decades ago. The implications for the global economy are equally significant.

The world’s major currencies aren’t tethered in the way they were in those periods, but gold and Bretton Woods both served as anchors for the world’s monetary system, and their demise reflected the economic and political disarray of their times. 

Today, the yuan is semi-pegged to the U.S. dollar. The arrangement serves as an anchor for China’s financial system, now the world’s largest by assets; for many currency systems in Asia and around the world; and for U.S.-China economic and financial relations.

 

If that mainstay ruptures, it’s liable to set off chain reactions inside and outside China. That’s why the loosening in currency policy by the People’s Bank of China this week, while it may seem unremarkable for most people, is an important development.

Late last year, the view was “This is all on Xi’s shoulders,” said Trey McArver, co-founder of Beijing-based research firm Trivium China. 

“Xi has personally said that he would handle relations with the United States and at this point, he has failed. Those relations are spiralling out of control.” [Bloomberg]

What is clear is that Xi Jinping has repelled the US Advance and this past week's Yuan Price Action was a message delivered with finesse and subtlety and whose import cannot be ignored. 

Given that neither President Trump nor Xi Jinping have it seems any desire to back up, the risks are skewed as follows. We should expect more volatility in the Feedback Loop that was characterised by Bloomberg Businessweek thus the chaos cycle -Powell speaks -Trump tweets -China reacts -Markets freak.

The Point is this the Yuan is now the catalyst and China has signalled it will be a shock absorber. Xi Jinping was also signalling he had control of the console. The direction of travel for the Chinese currency is therefore lower. The Yen and the Swiss franc considered safe havens in troubled times have been in demand and Sterling was described as ''drinking at the last chance saloon'' and closed on Friday with its nose just in front of 1.2000. 

Gold [safe haven] crossed $1,500.00 for the first time since April 2013. G7 Sovereign Bonds tilted further and deeper into negative territory. So this bid for Safe-haven assets has intensified and a weaker Yuan will only intensify this impulse as it courses through the veins of the Foreign Exchange markets. China has exerted the power of pull over a vast swathe of the world over the last two decades. We can call it the China, Asia, EM and Frontier markets feedback loop.

This feedback loop has been largely a positive one for the last two decades. With the Yuan now in retreat [and in a precise response to Trump], this will surely exert serious downside pressure on those countries in the Feedback Loop. 

To wit, emerging market stocks closed down for 11 days running , 12 being an all-time record which was narrowly missed. The Purest Proxy for the  China, Asia, EM and Frontier markets feedback loop phenomenon is the South African Rand aka the ZAR. 

The rand was down 0.4% to 15.1121 per dollar by 12:05 p.m. in Johannesburg, its weakest level on a closing basis since September 2018. The rand is also the most volatile currency in the world, with the one-week implied volatility climbing a fourth day. The Rand is at risk of a further asymmetric downside move.