FX MACROECONOMICS
may only have one political party, but its politics are as serious and intense as any place, though perhaps more subtle. President Xi has been gradually consolidating power. He is perceived as China’s most powerful leader since Deng Xiaoping.
While President Xi is overseeing the continued modernization of the Chinese economy, the political structure, if anything, has become more rigid. Many suspect that the anti- corruption campaign was primarily aimed at political targets. Xi appears to have tightened political control over society, including the toppling of some internet personalities, and limited civil rights expressions.
Te 19th Party Congress toward the end of 2017 is important. The key seven-member Standing Committee is set for a complete overhaul with only President Xi and Premier Li holding on to their posts for a second term, which has become customary in China. Tere are two aspects that will be closely watched. First, Xi’s successor is likely to be one of the new members. Second, there has been respect for the “seven up, eight down” rule, which means that if a member of the Standing Committee is 68 at the time of the Congress, he must retire, but a 67-year-old can still become a member.
If an exception
is made, it could spur speculation that Xi himself may seek a third term or retain extensive formal
18 FX TRADER MAGAZINE January - March 2017 power after the second term ends.
China’s economy appears to have stabilized, but the cost is increased debt levels. In addition, the powerful forces spurring capital outflows, among which are corporations paying down their dollar debt, have prompted Chinese officials to tighten capital controls. It is a precarious balancing act
that does not leave much margin for error.
At the same time, our long warning that the past appreciation of the yuan flattered measures of its globalization is being borne out in recent data, though it is now a member of the IMF’s SDR. Te share of foreign trade settled in yuan has fallen from 26% to 16% over the past year. Yuan deposits in Hong Kong are off 30% from their 2014 peak (CNY1 trillion). Foreign ownership of domestic Chinese assets peaked in 2015 near CNY4.6 trillion and has fallen to CNY3.3 trillion as of the end of Q3 ‘17. Te yuan itself has surpassed the Mexican peso as the most actively traded emerging market currency, but overall it is the eighth most traded currency, putting it between the Swiss franc and Swedish krona. In 2013, it was in ninth place.
The Dollar
Our broad outlook for the dollar remains intact. It is predicated on the divergence of monetary policy and interest rates. The traditional knock
On top of the monetary divergence, which, in
our conception, is
sufficiently encompassing to include the health of financial institutions, is the policy mix. A trajectory of tighter monetary policy and looser fiscal policy is associated with currency appreciation. This was the policy mix under Reagan-Volcker and in Germany when the Berlin Wall fell, and the country was reunited.
Also, we are concerned that political events, not just what we outlined above but those continuing over the next few years, are going to challenge the foundation of the European project. In the not-too- distant future, investors are going to have to contemplate a post-Merkel Germany and a post-Draghi ECB. To be sure, these developments are not imminent, but for long-term investors, the European outlook is particularly concerning.
Marc Chandler
Global head of currency strategy at BBH Brown Brothers Harriman
on the US, that having the dollar as the major reserve currency gives it an exorbitant privilege of lower interest rates, misses this key driver. Te US premium over Germany, the UK, and Japan are at multi-year extremes. This creates an incentive structure that encourages investment flows into the US and hedging non-dollar exposure.
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