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Dollar strength or yuan weakness?

Daryl Guppy
Daryl Guppy9/15/2022 04:48 PM GMT+08  • 5 min read
Dollar strength or yuan weakness?
When businesses, investors and traders assess the yuan’s trajectory, it is more important to consider the impact of US dollar strength in addition to other factors. Photo: Bloomberg
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To what extent is the movement in the Chinese yuan an indication of economic weakness? Headlines are fond of thundering that the yuan is on course for its most significant annual fall against the US dollar despite Beijing’s decisive steps to stem the currency’s decline due to a growing monetary policy divergence between China and the US.

The latter is aggressively lifting interest rates, while China is not. Economists warn that further depreciation is probable as the US Federal Reserve raises interest rates while China’s central bank maintains loose policies. Commentators suggest these policies are designed to steady the economy.

The beginning of this sell-off is attributed to when Chinese President Xi Jinping’s harsh Covid-zero policy plunged the financial hub of Shanghai into a two-month lockdown in April. It is said that this puts pressure on exchange rate stability, an issue of significance to anyone involved in cross-border trade.

To this analysis is added a political dimension. The yuan’s weakness comes at a pivotal moment for China’s Communist Party in the leadership summit in October, when President Xi is expected to secure a third term in office.

The drop of 8% against the US dollar since March puts the yuan on track for its biggest annual fall since China abandoned its longstanding currency peg and moved to a managed floating exchange rate in 2005.

Stern stuff, but it does not stand up to being unpicked. The clue comes with the reluctant admission that the decline has accelerated recently as the dollar gained against a raft of global peers.

See also: Sensitive time to do business in China

There is no doubt that the yuan moves are discomforting, but they are neither uncommon nor unique to China. The currency story of 2022 has been the strength of the US dollar. Since March, it has risen by around 13% — putting tremendous pressure on any currency, even vaguely associated with the US dollar.

The Australian dollar has moved 8% against the US dollar in the same period. The 8% move is despite the Australian reserve bank outpacing the rate of US interest rate increases with multiple moves of 50 basis points. The movement of the Australian dollar in a fully free-floating market is 8%.

The move in the yuan in an essentially floating market is also 8%, which tells us about the dynamics at play. Since 2005, the yuan has drifted into a broader trading band based on a mid-point set daily by the People’s Bank of China. It is not a total float like the Australian dollar but a good reflection of market forces.

See also: China leaders may signal policy shift to economy from Covid zero

The 8% move in the yuan does not reflect interest rate divergences in the same way that the 8% move in the Australian dollar is not interest rate related. Interest rates are a factor, but they are not the main driver.

The similarity of the degree of movement between the two currencies suggests that these changes are more directly related to the steady increase in US dollar strength. When businesses, investors and traders assess the yuan’s trajectory, it is more important to consider the impact of US dollar strength in addition to other factors.

Technical outlook for the Shanghai market

The Shanghai Index is moving in a tight sideways trading band with a slight downwards bias. This is a whipsaw market, although the whipsaw moves are not as great as in US markets.

The lower edge of the sideways pattern is around 3,170. The upper edge is about 3,290. These are extensive and indistinct parameters. The index is oscillating around 3,220, as shown in line B. The sideways movement contains some rapid rally and retreat behaviour. On balance, this index continues to show downside pressure, but it is not strong.

The Guppy Multiple Moving Average (GMMA) relationships show a resumption of downward selling pressure, but this is so weak that it cannot be defined as a significant trend. The slight expansion in the long-term GMMA shows weak selling pressure. The increase in selling pressure is shown when the long-term GMMA expands significantly, which has not developed in the past week.

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The expansion and compression activity of the short-term GMMA shows traders are not confident that the market can establish a strong trend direction, so they are taking short-term profits from the rallies. This activity reinforces the rally and retreat behaviour that makes the sideways market.

The long-term GMMA is moving sideways. The compression shows a high level of agreement about the index’s price and value. Such agreement periods about price and value are often followed by significant disagreement.

The short-term GMMA has again moved to test the lower edge of the long-term GMMA, confirming a marginally stronger but short-term bullish environment.

A weak head and shoulder trend reversal pattern continues to develop with two right-hand shoulder peaks. These extended developments have become a common feature of this pattern in recent years. The head and shoulder pattern is bearish, with a downside target near 3,100.

Daryl Guppy is an international financial technical analysis expert and special consultant to Axicorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for two decades. Guppy appears regularly on CNBC Asia and is known as “The Chart Man”. He is a national board member of the Australia China Business Council. The writer owns China stock and index ETFs

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