The Chinese Yuan is Now in Play…And This Could Mitigate Any Global Slowdown
The clear and present danger to the global economy is inflation because global central banks are starting to take aggressive actions to deal with what they now believe to be non-transitory inflation. The Fed funds futures curve is signaling a tightening campaign not seen since 1994—and potentially even more aggressive given the balance sheet run-off. There are six more Federal Reserve meetings this year, so in order for the fed funds upper target to rise from the current 50bps to 2.5%, there are going to have to be at least two 50bps hikes in the balance of the year.
The Fed’s policy path stands in contrast to countries like Japan or China, who with economies in need of monetary support, are not following the Fed’s path higher. The release valve is the currency. Japan has been on the frontlines of this battle lately defending its 25bps cap on 10-Year Japanese Government Bonds.
But now, it appears the Chinese Yuan is in play as the next currency to weaken as a result of policy divergences. And a weakening Chinese Yuan is more important to the global economy than the Yen. In the chart below we can see how the Chinese Yuan has been in a structurally rising trend since the onset of the COVID pandemic. Now, with the war in Ukraine in progress, it appears that the direction of travel for the Yuan may be lower. It looks like money is trying to leave China as measured by the spread between onshore (CNY) and offshore (CNH) which opened up in the days following Ukraine’s invasion. Perhaps investors are realizing that money invested in countries of “rule by law” are bad investments.