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China's capital markets could expand in the coming months. Here's why

Daryl Guppy
Daryl Guppy • 5 min read
China's capital markets could expand in the coming months. Here's why
The yuan recently jumped to its highest level relative to the US dollar since June 2018. What's the impact of this?
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Photo: Bloomberg

The taste of freedom is a heady elixir — just ask the Chinese yuan.

Largely freed from the constraints imposed by a direct link to the US dollar, the yuan has been freer to reflect the true value of the currency.

There have been changes to the way the daily reference peg is implemented, and the reference point for the value of the yuan.

Each day, the yuan is able to traverse freely within a 2% trading band defined by the People’s Bank of China (PBOC).

When considering the band for the next trading day, the PBOC uses the previous day’s close as a reference point.

The result is that the yuan trend is defined by a cascade of trading bands.

It is not directly reactive to market pressures in the same way as the dollar index, but it trades much more freely than currencies which are directly pegged to the US dollar.

Recent PBOC reference rates have been near to the market-determined value of the currency, suggesting authorities were willing to allow the currency to further appreciate.

The value of the yuan is largely set by market forces rather than Government manipulation as alleged by former US President Donald Trump.

The value of the US currency in the Dollar Index is set with reference to a basket of currencies, including the Swedish krona.

The value of the yuan is also set with reference to a basket of currencies, although we are not privy to the currencies included.

However, this reference point gives the yuan greater flexibility and a more direct relationship with market forces.

The result of this current freedom has a significant impact for those who do business with China.

Recently, the yuan has jumped to its highest level relative to the US dollar since June 2018. The gain since January against the US dollar is around 2%, making it one of the best-performing currencies in Asia.

This has two impacts. First is from China’s perspective — it takes the sting out of rising commodity prices.

The increase is a boost to Chinese importers of commodities, including iron ore, which are typically priced in US dollars. A strong yuan provides an offset to strong US dollar commodity prices.

Secondly, this reflects increasing investor appetite for the attractive yields of China’s government debt.

It also reflects recent moves to give better access for foreign investors to tap China’s expanding capital markets.

The yield on China’s 10-year government bond is just above 3%, compared with about 1.6% for the US equivalents. The difference has increased the appeal of China’s government debt for foreign investors.

Official Chinese government figures show around US$93.6 billion ($123.8 billion) has flooded into government bonds this year as they were included in many popular global fixed-income indices.

Investment capital is moving into China despite current US President Joe Biden’s hard-line rhetoric, which is coming more to resemble King Canute’s attempt to hold back the tide.

The yuan’s freedom to move profits China against charges of currency manipulation provides a growing and attractive competitor for capital and trade settlement.

In fact, it could further strengthen in the coming months.

Technical outlook for the Shanghai market

The Shanghai Index has developed a consolidation pause around 3,600. This is near to the projected target level for the breakout from the up sloping triangle pattern.

This behaviour is similar to the consolidation around this level pause seen in January.

The rally is well supported by traders as shown by the wide separation in the short-term group of moving averages. The short-term Guppy Multiple Moving Average (GMMA) indicator shows how traders are working in the market.

This wide separation shows strong support but we expect that some traders will start to take profits. This will cause the index values to dip towards the lower edge of the short-term GMMA.

The key feature to watch is the way the long-term GMMA behaves. This tracks the behaviour of investors.

If investors take selling as a sign the trend is ending, then this group of averages will quickly compress.

If investors are confident the trend will continue, then this group of averages will remain well separated.

This shows investors are coming into the market as buyers.

The first upside target for the breakout rally was calculated by using the width of the base of the triangle and projecting this value upwards. The same technique can be applied to meet the next upside target near 3,720.

The 3,720 target level is also near to the peak of Shanghai Index activity in February.

If support is strong in the current consolidation area, then the index can move quickly towards the 3,720 targets.

This is the most important behaviour that both traders and investors will be alert for over the next few days.

A failure of support has a downside target near 3,545. This is the current value of the lower edge of the short-term GMMA.

A fall below this level will test support created by the long-term GMMA around 3,520.

Currently, momentum indicators like the Relative Strength Index are showing confirmation behaviour. The trend line along the peaks of the RSI is sloping up. The trend line of the Shanghai Index is also sloping up so the indicator confirms the index trend activity. Targets are alert for any RSI divergence signal as this is usually a precursor to an end of the current trend.

This is currently a strong breakout that has developed a consolidation period. The rebound from this consolidation area will move the anchor points for an up trend line, which can be used to define the remainder of the up trend development.

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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