At the start of the week, commodity currencies got a bump. This came after the PBOC reduced reserve requirements for banks (RRR as it’s known). This highlights the importance of the Chinese credit situation in forex, and why traders ought to keep track of it.
Japan, New Zealand and Australia, in particular, are intimately related to their largest trade partner, though in different ways.
Chinese authorities have been taking a series of measures in an effort to offset the economic impact of the ongoing trade war with the US. Many of these are related to credit and loan capabilities. Therefore, they are directly related to how much Chinese businesses, consumers and individuals can buy or invest from other countries.
Chinese investors were the drivers of the real estate boom in Australia. And the collapse of it is what precipitated the decline in the economy and the change in outlook by the RBA.
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What We Are Looking For
The forecast is for a substantial increase in the total number of new loans for Chinese enterprises and individuals. The consensus shows CNY2.2T new loans, compared to CNY1.5T in the prior month.
A result like this would be the highest amount since the Lunar New Year. Around that time, there is typically an unusually large amount of borrowing. However, this would be the largest amount of new borrowing in years, on a seasonally adjusted basis.
The normal range for this figure is between CNY1-2T. Projections above that could have a significant market effect. More borrowing in China often correlates with increased capital outflows to pay for exports and make foreign investments. The largest beneficiaries are the US, Australia and the euro area.
Much smaller in comparison to other countries, but bigger as a proportion, New Zealand receives a significant amount of capital investment from China.
On the flip side, a miss in expectations would likely contribute to weakness in currencies from countries who trade significantly with China. This primarily impacts Australia and New Zealand. The yen would likely move in the other direction, as a safe haven play.
The End of Carry Trade?
Among the primary drivers of strength in the NZD and AUD has been their relatively high interest rates supported by their erstwhile conservative reserve banks.
Since the last recession, the bond yield spread (that is, the difference in cost to borrow money) between Australia and the two largest economies in the world has been around 150 basis points. With the RBA aggressively cutting rates, that spread could shrink if the Fed doesn’t follow through with a rate cut in September.
That would make the carry trade option increasingly less profitable. This means less interest in buying dollars of the Australian and New Zealand persuasion. While governments and banks might see this as a positive because it helps exporters, it would put medium-term pressure on the currencies.
The combination of weaker exports to China would imply a generally weak outlook for both the NZD and AUD in the near future.
It’s Not Just Interest Rates
What could push in the opposite direction are unconventional easing measures. These include the rumored QE plan from the ECB, and what was effectively an interest rate cut in China last month.
Increased liquidity in such a low interest rate environment would be searching for yields. And even with the rate cuts, commodity currencies are still the most attractive.
The exception there, however, is Canada. With not even a rumor of rate cuts and largely sidelined by the US-China impasse, Canada has remained strong. It’s bond yields are now just a quarter-point away from Australia And the next rate cut from the RBA could just push carry traders to look to the north for a better investment. That would further pressure the NZD and AUD but help the CAD.