Is the CNY telling us something important?
October 12, 2020
While everything that is not Covid or Trump (or both) is getting pushed to the side at the moment, there are actually some really interesting things going on elsewhere that deserve our attention. In particular one trend that seems to be emerging from the FX markets is the strength of the CNY, the offshore Chinese currency, which rallied strongly on Friday, taking it to 6.6947 against the US$, fractionally above the level that appeared to be some form of resistance in February and April 2019, as we can see from the Chart. The CNY had its strongest quarter since 2005 during the last quarter and is now continuing that strength in October. Is this telling us something?
Chart 1. Will China let the CNY break out?
This is certainly partly a reflection of some dollar weakness generally – likely associated with international investors withdrawing to the sidelines as we discussed in recent market thinking articles. However, it has some extra significance because of the semi fixed nature of the Chinese currency. The key question for FX markets is thus will China allow the currency to appreciate against the US$? Probably.
However, it also raises important questions for Asset Allocation and in particular if we look beyond the short term technicals and at the likely underlying causes of the strength in the CNY, we should be asking are they telling us something about future capital flows? We think so. In our view they are telling us to look beyond the Blue Team versus Red Team theatre of the US Elections to the more important strategic issues of Blue Team US versus Red Team China.
As always, it is important to look at flows and liquidity rather than the high level macro data and undoubtedly part of the recent CNY strength will be a result of flows into Chinese debt markets and perhaps equally importantly a lack of flows out of China into US debt markets. The notion that China can not survive without selling goods to the US and that it has no alternative but to buy over-priced US Treasuries is a misconception still wired into much US investor (and public) thinking. At the same time, the China IPO market continues to expand rapidly, particularly in Health Tech and Fin tech, which is acting as a further magnet for capital and having other impacts on markets. For example, as the ever reliable Sean Darby at Jefferies points out, the recent IPO of Nongfu Spring in Hong Kong was 1,147 times oversubscribed which tied up around a third of the liquidity in Hong Kong for a brief period! The HKMA knows that of course, but has bigger issues on its hands, after all with the HK$ pegged to the US $ the HKMA is struggling to keep the currency within its band – far from collapsing as the US hedge funds were predicting only a few months ago. As we noted at the time, Beijing was always going to support Hong Kong in its role as a capital market inter-connector with the rest of the world. As they are doubtless saying in a ministry somewhere, ” how’s that 200x leveraged bet working out for you at the moment Kyle?”
This also touches on a number of other issues of geo-politics; perhaps no coincidence that Mike Pompeo announced another round of sanctions on Iran on Friday, which if nothing else will simply drive Iran closer to Russia and China and deliver exactly the sort of EurAsian bloc that the US is supposedly trying to avoid emerging. As noted last week, US foreign Policy is unlikely to change much regardless of who wins the Election. Trump aside, the Enterprise Owned State policies of the Democrats and the Republicans are pretty indistinguishable, which is exactly why we should focus on Blue versus Red at the international rather than intra-national level.
Medium Term Opportunity in Asia
Of course part of the upward pressure on the HK$ is the upcoming Ant Financial IPO with up to $100bn of potential capital inflow for the HK leg of the floatation. Ant Financial captures so many aspects of the China versus US dynamic and in particular it tells the story of how China has transformed its banking system since the Global Financial Crisis. It combines all aspects of the digital transaction economy, using mobile apps, big data bank lending, digital transfers and payments systems and consumer finance. When it floats, it will not be in the US, but it will be the largest IPO ever, which tells its own story – as does the contrast with the previous largest IPO, the fossil fuel business Saudi Aramco.
At some point (soon) investors in the US are going to look beyond the domestic propaganda and realise that the world has moved on rapidly and that the S&P500 may not reflect the true relative health of the US versus the rest of the world. In particular the view of China remains at least a decade out of date. It always struck us as interesting for example that when Spike Jonze wanted to represent the LA of the near future in his film ‘Her’ he filmed all the City scenes in Shanghai. And that was in 2013. Guess which city has improved most since then?
When Hollywood wanted to represent a future LA, they used a present day Shanghai
With the US now approaching 60% of Global Market Cap and any new administration presenting a risk to the delicate balance of forces that have propelled markets to these heights, are we looking at a Nikkei 36,000 event?
Near Term Uncertainty in US
To return to the immediate short term uncertainties, we continue to be concerned that the whole Mail-in voting issue is going to lead to weeks of uncertainty after the Election. Indeed it is extremely likely that we simply won’t actually know who won for perhaps several weeks. To be clear, this is not voters requesting a postal vote – something which has a long history across the country – it is States sending out mail-in ballots unsolicited, which naturally requires clean, up to date, voter databases and close monitoring for fraud and mishandling. As of 2020, only 5 states have ever had any experience of doing this, so the potential for both mishap and mischief is clearly enormous.
As with seemingly absolutely everything in the US these days, this is a partisan issue; President Trump has already expressed concerns while the Biden campaign has dismissed them. As a result, most Republicans will vote in person – not trusting their mail-in vote to arrive – while by contrast most Democrats will use mail-in votes as a statement, in the same way that they wear facemasks to demonstrate they are ‘Not Trump’.
This of course means that on the day of the count, Trump has a ‘good’ chance of winning, until that is the postal votes come in. Those who remember the Bush/Gore Florida vote and the hanging Chads will know that every last vote will be fought over. Thus, while traditionally a major part of any post election move is a shift (usually reduction) in the uncertainty premium, there is a strong possibility this will simply not happen post November 3rd. It seems likely that the $ will go down rather than up should this happen, a further reason to perhaps start to divest from some $ assets.