More on the effects of China’s widening of it’s USD/CNY trading band
As I mentioned earlier, there are two ways of viewing this event and I believe that the short-term effects may well be bearish for ‘risk’ currencies like the AUD but the medium term effects are likely to be more positive.
USD/CNY has been pretty steady around 6.3000 for the last few months and the 0.5% trading band has seldom been tested. Now that the band has been widened to 1%, we will have to wait and see whether this leads to an increase in volatility. Increases in volatility will lead to a general decrease in overall positioning and as the market is usually long of AUD (interest rate plays), any vol rise will see the AUD sold off in the short-term. Also, Chinese demand for currencies like AUD, JPY, EUR, GBP etc is likely to lessen as they will spend less buying USD/CNY to keep it up and therefore will need to do less rebalancing to keep its FX reserve balance ratios in check.
The band widening can also be seen as a sign that the Chinese authorities are very confident that their economy will continue to grow. The most likely scenario of band widening is that the CNY will strengthen and the Chinese obviously feel that their exporters will be able to deal with additional Yuan strength. This is where the medium-term risk plays may see some benefit.