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Falling yuan is more evidence of China tightening

posted on February 26, 2014 at 1:23 pm
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It sure looks like the People’s Bank is tightening again.

China’s yuan was down 0.4% against the dollar at one point yesterday. That brought the currency’s decline to almost 1% since Wednesday, February 19. For most currencies a 1% drop in a week isn’t a huge deal. Just normal volatility, the markets would say. But this is the yuan, the very tightly managed yuan. China’s currency doesn’t move up or down unless the country’s central bank decides to let it move. So the move has set off loud alarm bells: Are we looking at a new policy move by the People’s Bank of China designed to 1) limit speculation in the currency, 2) pave the way for a wider trading band than the current daily maximum of 1%, and 3) reduce upward pressure on China’s money supply.

It’s the last that is making the markets the most nervous. Add a decision (if that’s what it is) to let the yuan fall together with figures from the People’s Bank showing it drained 100 billion yuan ($16.3 billion) from the financial system in the past week and you’re got solid evidence that the central bank has decided to tighten–again.

And that might be evidence that the People’s Congress, meeting next week, will announce a growth target for 2014 lower than the 7.5% target for 2013. Thinking here is that a lower growth target would give the central bank more room to tighten monetary policy.

All this is just starting to ripple out through Chinese financial markets—if only because any conclusion that we’re witnessing a shift toward tightening of the sort that knocked China’s equity markets into a bear in 2013 is so tentative. Forecasts for GDP growth for 2014 do continue to move lower. And the cost to buy a credit default swap to insure against a drop in bonds is moving higher.

Most importantly for investors trying to figure out how to time any buys in the Chinese market—or indeed in any emerging market—I’m starting to hear talk about what the People’s Bank will do later in 2014 to revive growth after the growth rate moves lower in the next quarter or two. One projection making the rounds is that the People’s Bank will cut reserve requirement ratios for Chinese banks to 19% from the current 20% to lower borrowing costs later this year.

The next development to watch is to see what growth target for 2014 emerges from the People’s Congress meeting next week.

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One comment

  • BigBlueFan on 27 February 2014

    I’m confused by this. Shouldn’t “tighter” monetary policy, all other things being equal, lead to a stronger currency? If the speculated motivation is to be consistent with a lower growth target, I sort of get it. But it’s certainly not intuitive.

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