In my previous post, I covered the little-known, yet important facts about the Chinese currency or Renminbi.
In this post, let's explore the state of China's economy, and how you can apply this knowledge and express your conviction through FCNH (USD/CNH) futures.
The Renminbi (or Yuan) vs the USD
As a whole, the USD has strengthened against the Renminbi in 2023. In other words, the Renminbi has been weakening against the USD.
It'd be interesting to explore what it is the case in the next section,
China's current state of economy 2023/early 2024
It'll be crucial for us to understand the fundamentals of the China economy, especially in 2023 for us to make an informed trade decision while trading the FCNH.
#1 Opposite rates decision vs the US
In 2023, as the US and most other global economies are raising rates, China is among the few countries that have not raised interest rates, choosing instead to cut rates as other countries increase theirs.
One key reason behind this is because China's economy has been struggling with slowing prices (or deflation) since early last year, forcing policymakers to cut interest rates to spur growth even as many developed economies like the US were focused on taming stubbornly high inflation.
As a result, the larger the difference in interest rates between US and China, the weaker the Renminbi as capital tends to flow to higher-yielding USD than lower-yielding Renminbi.
#2 Struggling property/real estate sector
The struggling property sector of China also posed further challenges in 2023 and 2024.
Let's look at some figures:
China’s new home sales dropped 6% in 2023, with secondhand home prices declining in major cities
Developer Defaults: Real estate firms faced $125 billion in bond defaults between 2020 and 2023. Many of them have either launched or are in the process of starting debt restructuring processes to avoid facing bankruptcy or liquidation proceedings. In fact, China Evergrande was ordered to liquidate in January 2024.
#3 Declining export & consumption
Given the overall tricky economic condition globally, 2023 has also been challenging for China's exports.
In 2023, China's annual exports dropped for the first time in seven years (since 2016) due to sluggish demand.
While retail sales rose 7.2% for the whole of 2023, it is the weakest China has seen since 1999, (excluding 2020 and 2022, two years badly affected by COVID-related lockdowns):
#4 Deflationary risk
Furthermore, China has been faced with the risk of price decline (ie. Deflation), with inflation falling in the last 3 months of 2023, as well as a -0.8% inflation rate in January 2024, before posting a +0.7% inflation rate in February 2024.
While the general impact of having a weak currency tends to be an increase in export, leading to companies making more money, and employees getting paid more which leads to an increase in domestic demand and healthy inflation, the reality seems to be more tricky for China.
The reality is, an already low consumption trend (weak demand), leads to an unhealthy deflation (price falls), Chinese households delay their spending in hope of getting goods & services at a cheaper price.
As a result, the state of China economy is in a tricky (and unhealthy) loop, which will depend on the wisdom of Chinese policymakers to resolve.
Ideas to consider while trading FCNH in 2024
To begin this section, let's recap the big-picture context:
The Renminbi has weakened against the USD in 2023.
At the same time, China is facing deflationary risk due to weak economy fundamentals, such as a challenging property sector and weak export & consumption.
The silver lining that comes with a weaker Renminbi is, imported goods are relatively more expensive. Hence, we'd want to observe if a weaker Renminbi raises domestic price of imported goods enough to help unroot China from its current deflationary condition?
The case for a weaker Renminbi
Theoretically, it is easy to engineer a weaker Renminbi, which is simply by cutting rates further.
However, IF the US FED begins to cut rates this year, the US–China interest rate differential will start to shrink, leaving the Renminbi more likely to strengthen than weaken.
The case against a weaker Renminbi
China’s trading partners would be less willing to accept Renminbi payments if all they can think is that the currency will keep losing value.
Increase capital outflow to places/countries that offer better interest. (eg. US)
As such, to trade FCNH (or the China market) in 2024, I think there are 4 key points to be followed closely, namely:
Would the Chinese authority cut rates in an attempt to further spur growth? If yes, it'd be bullish for FCNH (USD/CNH) as the Renminbi will weaken further against the USD.
In my opinion, the Chinese authority would likely NOT increase rates, as increasing rates in a challenging economy would likely crumble it further.
Would the US FED cut rates? If yes, by how much and how frequent? FED cutting rates in the US would likely lead to a closer gap between the interest rate of the US and China, which would be bearish for FCNH (USD/CNH) as the Renminbi will strengthen against the USD.
If the scenario in (3) happens, it'd pose a challenge to China's export, which will be difficult for the Chinese authority to address.
Verdict: Understanding the big picture of China economy to trade FCNH
To trade the FCNH effectively, I believe it is necessary for a trader to understand the context of the Chinese economy.
I hope you like this post, and consider checking out the blog of this site for more useful content!
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Disclaimers
Any of the information above is produced with my own best effort and research.
This post is produced purely for sharing purposes and should not be taken as a buy/sell recommendation. Past return is not indicative of future performance. Please seek advice from a licensed financial planner before making any financial decisions.
Leverage is a financial tool that comes with its advantages and risks. Please learn and understand both the upsides and downsides of leverage before using it for trading.
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