CNY > USD > EUR

We have long argued that the core fundamentals of the Chinese Yuan (CNY) are robust and resisted the fashionable call in the market a year ago for the CNY to depreciate or be devalued. We strongly argued at the time that Beijing is not of a mercantilist mindset as many commentators were stating, and that the economic fundamentals of China, both cyclical and structural, suggested a positive medium-term trajectory when compared with the USD or the EUR. In October, the People’s Bank of China (PBoC) lowered the risk reserve ratio for FX forward trading from 20% to 0%, as well as removing the countercyclical factors. Instead of an expression of the PBoC’s concerns of the recent RMB appreciation, we believe the actions represented China’s campaign to promote the RMB internationalization and to entice foreign institutional investors to invest big in China’s financial markets. As a key part of the multi-year plan, China is going to make the Chinese financial markets more balanced, in that foreigners must have a certain level of ownership in Chinese assets. One reason is that China is short of hard currencies: it no longer runs a meaningful CA surplus that allows them to expand overseas. At the same time, there is huge pent-up local demand for foreign assets (which we estimate to be in the range of USD4-5 trillion now). The solution is to engineer a counter flow of the same size by inviting foreigners to invest in China. This was why China accelerated financial sector reforms and liberalisation.

Over the medium to long term, although there will be ups and downs for all currencies, we believe the relative performances of the major currencies will likely be CNY > USD > EUR. On the CNY side, we suggest the PBoC is the ‘Bundesbank of Asia’, in light of its philosophy and its prudent restraint in resisting printing money. In addition, the latest Five-Year Plan should lead to meaningful structural upgrades in China’s real economy and the financial sector. As a result, we think the CNY will perform like the ‘Deutsche mark of Asia’, and will be favourable to the other major currencies. On the EUR side, despite the heightened emotions and the significant speculative positions in EURUSD, we should be reminded that, since the inception of the euro, EURUSD has traded within roughly a range of 0.80 at the low and 1.60 at the high. At 1.17, we are very close to the mid-point of this range and the ‘IPO’ rate of 1.17 in January 1999. The latest hype about global central banks falling in love with the European Recovery Fund and the new debt issued by Brussels seems mis-placed in our view, both in terms of the scale of the likely new issuances and how the reserve managers around the world make their allocation decisions. In sum, we believe the EUR’s out-performance in the past few months will likely turn out to be transitory, and the real out-performer may be the CNY.

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