Macro: The Bottom Line (3/17/2014)

-China confirms expectations by widening yuan trading band

-ECB President Draghi (finally) awakens to the Euro's strength

-Another update on Ukraine

China confirms expectations by widening yuan trading band:

 

It wasn't too long ago when we posted an extended note on the Chinese yuan. If you recall, we noted in our post that the PBOC (China's central bank) was deliberately engineering weakness in the renminbi, in order to convince the markets that the currency is not a riskless one-way bet - ostensibly ahead of a relaxation in its exchange rate management. Well, policymakers did just that over the weekend, increasing the currency's allowable daily trading band to +/-2% around the PBOC's daily reference rate (from +/-1% previously). The immediate reaction as of the Asian market open on Monday was as one would expect, with the RMB selling off amid heightened demand for put options on the currency. But does this herald a longer-term spell of weakness for the renminbi? 

We continue to stand by our previous view, namely that the near-term doldrums for the RMB are just that: near-term. The fact is, the PBOC has picked possibly the perfect-storm moment to announce this latest liberalization of the exchange rate. The past two weeks have not been kind to the China bull: just as investors were still reeling over the end-of-February yuan weakening, you also had weak economic data (including as whopping year-over-year 18% drop in exports), as well as the country's first onshore corporate bond default. But what do these events mean in a broader context? Well, the seemingly catastrophic exports data is a rough indicator at best, heavily distorted both by the effects of the Chinese New Year and over-invoicing practices last year that artificially inflated the 2013 number (practices that Chinese authorities have since cracked down on). As for the corporate default, this has shown no signs of spiraling toward a systemic crisis. Instead, the considerations that are most relevant remain the same: a still-formidable export engine, massive FDI inflows, favorable balance of payments (especially compared to most EM peers), and a government with deep pockets in case events take a turn or the worst. In short, the recent events do warrant some additional attention to developments in China. But all things considered, this soft patch in the RMB represents an opportunity to buy into the yuan.

 ECB President Draghi (finally) awakens to the Euro's strength

 

Last week, we posted a rather strongly-worded reprimand of the ECB's obstinacy in the face of the Euro's relentless climb toward 1.40. To summarize, we simply did not view the current situation in Europe - strong Euro, ultra-low inflation, stubbornly high unemployment, prohibitively tight credit conditions for small businesses for many countries - as sustainable. Something would have to give, and the very least the ECB can do is to show some concern rather than kicking the can down the road.

 

Well, ECB President Draghi seems to have finally awakened. At a speech in Vienna on Friday, Draghi noted that the Euro exchange rate would be more "relevant" going forward in deciding on the course of monetary policy. He added that should the strong Euro cause inflation expectations to become unanchored (in a way that could push inflation further toward zero), the ECB would answer with "additional monetary policy measures."

 

True, this is not recipe for action. But nonetheless, it's the most unequivocal sign yet that the top echelons of the ECB would be loath to tolerate a Euro exchange rate north of 1.40. Until we see more concrete signs or further jawboning from the ECB heads, it's still premature to call a screaming sell on the Euro. But the days of the currency's upward march are likely numbered.

 

Another update on Ukraine: The latest "big news" out of Ukraine is the announcement that over 95% of voters in Ukraine's Crimea region have declared support for a union with Russia in a referendum on Sunday. This effectively gives the go-ahead for Russia to annex the Black Sea peninsula from its neighbor. Only problem is: neither the EU nor the US recognize the referendum, and have threatened impose sanctions on Moscow (which will start with visa bans on Russian officials, but could evolve into something more serious such as economic restrictions). Despite the threat of an extended standoff between Russia and the West, we continue to warn against reading too much into the saber-rattling. After all, it's in both sides' interests to avoid rocking the boat too much and to avert broader economic implications.