CNY: State bank dollar selling unlikely to halt dollar demand

The dollar has weakened modestly today although we believe the short-term outlook remains positive with limited signs from China of any meaningful policy strategy to deal with the increasing drag on sentiment via the uncertainty emanating from the property sector. Signs of opposition to CNY weakness has helped stall dollar gains with USD/CNY gains reversing yesterday and helping to prompt a broader brief period of dollar weakness. Bloomberg news reported yesterday that state banks in China were instructed to sell dollars which prompted a notable AUD/USD rebound and general retracement of USD strength. USD/CNH fell sharply as well. This resistance is also evident in the widening divergence between spot and the PBoC fixing. Today, the PBoC fixing (7.2006) was set at the widest ever versus the market estimate (7.3047) underlining the growing resistance to further increases in USD/CNY.

The greater focus on China and the concerns over the property market are also evident in the strengthening of correlations between CNY and other markets. USD/CNY and copper has seen the 30-day rolling correlation increase to -0.70 – the strongest correlation in 18mths. The USD/CNY correlation with gold and other currency pairs are also strengthening as investors increasingly focus on China as a potential source of direction and increased volatility going forward. September and October are two notorious months of the year for risk aversion and increased volatility and the lack of policy action to address the problems could spark a bout of risk aversion.

Bloomberg reported yesterday a likely very wide divergence between official statistics on the property market and more on-the-ground data. Officials stats show new home prices as just 2.4% down from a high two years ago while existing home prices are down 6%. But private data and data from property agents indicate existing home price declines of between 15% to 25%.

That suggests problems could well worsen. We doubt very much that the signs of resistance to a higher USD/CNY will lead to a turnaround in USD/CNY. This strategy is very likely more about curtailing sharp moves and fuelling further appetite for dollars and for capital flight. The divergence between the PBoC fixing and market estimates of the fix is now at the widest ever, surpassing today the previous record from November 2022 when USD/CNY was last at these spot levels. Back then falling US inflation and falling US yields alleviated the upward pressure. That seems much less likely at this stage and a break higher through the intra-day high from last November of 7.3274 seems very likely, taking USD/CNY to levels last seen in December 2007.

RECORD DIVERGENCE BETWEEN PBOC FIXING AND MARKET ESTIMATE

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Underlying inflation remains firm  

The nationwide inflation data for July was released this morning in Japan and the data was in line with expectations. The drop in energy prices resulted in the core nationwide annual CPI falling from 3.3% to 3.1% but the core-core excluding energy, as expected, accelerated from 4.2% to 4.3%, matching the cyclical high set in May, which is the biggest increase since 1981. Outside of Fuel & Utilities every category recorded positive YoY gains. Food prices, which can be very influential in shaping inflation expectations accelerated further to 8.8%, a new cyclical high.

Furthermore, services inflation continues to strengthen as well, jumping from 1.6% to 2.0%, which was the largest increase since 1993, when tax increase periods are ignored. This will certainly help feed the view that underlying inflation pressures are continuing to build and sticky inflation suggests this time could be different in terms of inflation becoming more sustainable in Japan.

USD/JPY is lower today and the yen is the best performing G10 currency. The aggressive PBoC fix is certainly one factor with USD/Asia lower across the board. But USD/JPY has also reached the intervention zone and it looks like appetite to buy at these levels is receding. The rhetoric from the MoF this week is not yet at a level consistent with imminent intervention. The Obon vacation period was earlier this week and it may be that next week we will see a pick-up in verbal opposition ahead of the Jackson Hole symposium from 24^th-26^th August. We continue to believe that there is limited upside for USD/JPY from here and there are more attractive ways to benefit from US dollar strength than buying USD/JPY.

JAPAN SERVICES CPI HITS A NEW CYCLCIAL HIGH OF 2.0%

Source: Macrobond & Bloomberg

NOK: Norges Bank should keep open prospects of more hikes

Norges Bank is expected to hike its key policy rate today (0900 BST) by 25bps, taking it to 4.00%. Norges Bank signalled at the June policy meeting when they hiked by 50bps that they intended to take the key policy rate to 4.25%, so if 25bps is delivered today, any guidance in the statement will be important. Inflation in August came down more than expected offsetting the upside surprise in July. That plus the recovery of NOK versus EUR from the record level in May should allow Norges Bank to hike by 25bps today and leave open the prospect of more. Norges Bank will likely be conscious of the risk of increased volatility and risk aversion going forward which could fuel renewed NOK selling.

It’s also important for Norges Bank to leave open the prospect of more hikes given the policy rate in real terms remains deeply negative. Even after the sharper drop in inflation this month, Norway’s real policy rate remains the third lowest at -2.65% with only Sweden’s and Japan’s real policy rates lower. We believe it is no coincidence that JPY, SEK and NOK are three worst performing G10 currencies since the start of 2022.