(Bloomberg) — Chinese firms could also be enticed to sell a $1 trillion pile of dollar-denominated assets because the US cuts rates of interest, a move which could strengthen the yuan by as much as 10%, in response to Stephen Jen.
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The chief executive of Eurizon SLJ Capital said currency is now the most important risk that’s not priced in properly across markets — and the yuan may play an outsized role.
“Think an avalanche,” Jen said concerning the impact of the repatriation flows. The yuan “will appreciate and possibly be allowed to — five to 10% can be modest and acceptable to China.”
The speculation goes like this: Chinese firms could have amassed greater than $2 trillion for the reason that pandemic in offshore investments, parked in assets that pay higher rates than yuan-denominated ones, in response to Jen. When the Federal Reserve lowers borrowing costs, the appeal of dollar assets will erode and potentially spur a “conservative” $1 trillion of flows back home as China’s rate discount with the US narrows.
Jen, known for his work on the “dollar smile” theory, predicts the Fed will cut rates more aggressively than markets predict if US prices proceed to fall. That, together with an overvalued greenback, America’s twin deficits and prospects of a soft landing, is bolstering his conviction that the dollar will decline.
The final result is a Chinese currency that might well march higher against the greenback. It traded around 7.12 per dollar within the onshore market on Monday, having been as weak as almost 7.28 in July.
The rally might be even greater if the People’s Bank of China refrains from stepping in to take in dollar liquidity, London-based Jen said in an interview last week.
The case for yuan gains looks even stronger now after Fed Chair Jerome Powell said on the Jackson Hole symposium on Friday that the time has come for the US to chop its policy rate.
Nonetheless, such a move isn’t more likely to occur immediately after the primary Fed cut. It could occur when declines within the dollar speed up amid a so-called soft landing scenario, or where inflation eases within the US without triggering a recession, he said.
Yuan Pressure
Jen’s view chimes with those of Guan Tao, a distinguished economist at Bank of China International Ltd. who argued the yuan risks surging if a scenario just like the collapse of the yen carry trade plays out.
The fallout of the yen unwind was so seismic that it ripped across the whole lot from stocks to credit and emerging currencies. A crash within the yuan-funded carry trade — which involves traders borrowing the currency cheaply and selling it against higher-yielding alternatives — could unleash recent waves of panic especially across Asian markets.
Still, the PBOC can iron out wild swings, Jen said. Beijing has at all times been cautious with aggressive gains within the yuan as it may possibly dent export competitiveness and undermine the already sluggish economic recovery.
China’s foreign-exchange watchdog is already on guard as they gauge the impact of a stronger yuan on exporters, people aware of the matter said. And a few strategists have argued that carry trade centered round a weak yuan proceed to make sense given China’s mixed economic fundamentals.
The PBOC also has loads of measures to steer market expectations. Most recently it has used tools to encourage currency stability, similar to its each day reference rate for the onshore yuan and adjustments in the quantity of foreign-currency deposits banks have to hold as reserves.
Also, given the gap between Chinese and US yields remained wide despite some gradual contraction of late, corporates may not sell their foreign-exchange holdings anytime soon.
Others estimate China’s corporate money pile to be somewhat lower than Jen does.
Macquarie Group Ltd. estimates Chinese exporters and multinationals have amassed over $500 billion in dollar holdings since 2022. Australia & Latest Zealand Banking Group Ltd. pegs the number at $430 billion.
“The pressure might be there” on the yuan to rally, Jen said. “If we just assume half of this amount is the cash that’s ‘footloose’ and simply provoked by changing market conditions and policies, then we’re talking about $1 trillion price of fast money that might be involved in such a possible stampede.”
–With assistance from Qizi Sun.
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