With pollsters predicting that Donald Trump will soon be out of the picture, global investors can finally breathe a big sigh of relief. Foreign policy could become more predictable, so they can start buying Chinese government bonds, which actually pay interest. They can also invest in the mainland, where a successful Covid-19 containment strategy has allowed businesses to resume. Money managers won’t have to be on the edge all the time.
This is certainly what traders are betting on. In recent weeks, the yuan has appreciated strongly against the US dollar — so much so that over the weekend, the People’s Bank of China removed one of the signature tools it uses to stabilize a weaker currency. Shorting the yuan just became cheaper.
To unpack this, it’s worth asking what drives a stronger yuan. Is it China’s widening trade surplus, its resounding success in virus containment, foreign portfolio inflows, or Beijing’s relationship with Washington?
China’s trade surplus has been widening since May, as it exported masks, protective gear and work-from-home electronic equipment to the rest of the world. At around the same time, the PBOC tightened money market liquidity, causing a U-shaped rebound in government bond yields. Yet neither an improving current account nor a higher interest rate differential propelled the yuan higher.
The currency didn’t really take off until early August, when China and the US said they would review their phase-one trade deal, despite diplomatic scuffles over the “China plague.” Later that month, after the two sides met and reaffirmed their commitment, the yuan extended its rally. The currency’s outlook is getting even rosier in October, as the chance of a Joe Biden win rises to a record probability of 86%.
We’ve seen this before. In 2017, the yuan was also climbing, driven by a widening interest rate differential between China and the US That trend quickly reversed in early 2018, when Trump floated the idea of a trade war. In the last two years, US-China tension has become the biggest trigger for the yuan’s movements.
Dollar-based foreigners, lured by China’s high yield, have been wanting to buy yuan-based assets for a while. But Trump has always been the road block, threatening to tear up trade deals, forbidding pension funds from buying Chinese assets, and posting whimsical tweets in the middle of the night. Now that there’s a strong belief a blue wave will wash over the White House and Capitol, traders are finally positioning for a post-Trump world, which sees the yuan as an important asset class.
In November 2016, when Trump staged a surprise presidential win, the Mexican peso, viewed as a proxy for Trump’s anti-trade stance, tumbled. Four years on, Mexico almost seems like an afterthought. Trump set his sights on a much bigger emerging power. The yuan is where the action is.
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