China to start shaking up global currency markets
The likely admission of China’s currency to the IMF’s Special Drawing Rights (SDR) next year could usher in profound changes in forex markets and fund flows across the global economy.
The CNY becoming a component of SDRs, alongside current constituents USD, EUR, JPY and GBP, will not in itself be that consequential, but it’s deeply symbolic as it establishes its reserve currency status. It would mark a leap forward in China’s efforts to internationalise its currency and to drive domestic financial liberalisation and is keenly supported by the People’s Bank of China.
Various estimates suggest that the coming of age of CNY could attract $300 billion to $1 trillion in asset allocations over a period of five years – suggesting some big movements in exchange rates.
It’s likely that many fund managers, corporate treasurers, Sovereign Wealth Funds and central banks will want to up their exposure to Chinese assets. In the meantime, Chinese fund managers will go in the opposite direction as they diversify their portfolios abroad.
Nonetheless it’s not a forgone conclusion that SDR inclusion will lead to a firmer CNY. This will depend on a number of factors:
1. China may stop supporting its currency and pursue more aggressive monetary stimulus hoping support for CNY will come from outside investors instead, which may or may not happen.
2. Demand for Chinese assets by foreigners will depend on four factors: 1/ China's economic performance 2/ Ongoing financial liberalisation 3/ Attractiveness of CNY instruments 4/ Sophistication of Chinese financial markets.
3. With a reserve currency of its own, there’s less need for China to hold vast FX reserves of $3.5 trillion. They could be run down as it transitions to a consumer driven economy and imports more.
4. Given China’s status as a top economy and trading nation, many foreign central banks are likely to shift reserves into CNY and will sell other currencies to do so.
5. Financial centres, such as London, will find ways to recycle and reinvest CNY outside China potentially creating more demand for the currency.
6. China’s biggest trading partners could start paying for transactions in CNY instead of USD.
These shifts won’t happen immediately, but they could unleash powerful new forces in the global economy with some established currencies, such as the USD losing out as could smaller ones, such as GBP as central banks reshuffle their reserves – particularly those in Asia with close trading relationships with China.
Eventually CNY could emerge as major global currency for traders alongside USD and EUR. The financial liberalisation of China and its quest for a global reserve currency is about supporting the country’s shift to a consumer driven economy.
TECHNICAL ANALYSIS: AUD/USD could re-test key support levels
AUD is widely seen as a proxy for CNY as China absorbs over a third of Australia’s exports, which mainly comprise Iron ore, coal, petroleum products and gold. The slowdown in China has had a big impact on commodity prices and the AUD. Despite this the Australian economy is still managing to grow due to a combination of lower interest rates and a cheaper AUD.
Indeed, the last time AUD/USD traded above parity was in 2013 and now trades just above 0.7000. Given the ongoing economic slowdown in China and its move towards a consumer driven economy and with the US looking set to raise interest rates in December – there could be more losses to come for AUD/USD.
It did briefly breach 0.7000 on a number of occasions in September when it hit a low of 0.6907 – both these are key support levels, which are unlikely to be decisively breached without a considerable struggle. Since then AUD/USD recovered hitting a high of 0.7382 and has since been working its way lower again.
The real test to see whether this a consolidation pattern in a downtrend is to see if the pair can clear support around 0.7016 followed by 0.6981 with 0.6937 and 0.6907 acting as further targets.
The minutes from the US Federal Reserve on Wednesday could certainly be a catalyst for action in either direction, depending on how bullish or bearish they are. Resistance levels for AUD/USD are placed around 0.7160, 0.7191 and 0.7251.
By Justin Pugsley, Markets Analyst, MahiFX