The problem with writing blog posts in advance (I wrote most of this on the 25th) is that they may very well be rendered obsolete by the passage of events, especially when covering financial markets. Hopefully, in this case, the heightened uncertainty in emerging markets — as well as the durability of the yen carry trade — will not change the outlook for the CNY very much.
From IDEAglobal, a forex consultancy firm, in an electronic newsletter on “Asian Strategy for the European Session” (rec’d 9pm Pacific time on 2/28):
After the Shanghai stock market took a breather on Wed, following Tuesday’s 8.8% plunge that contributed to a global selloff, the market was under the cosh anew on Thursday – down over 1% at present. Financial blue ships were sold down, aping the trend witnessed in their Hong Kong-listed H share counterparts. With the NPC kicking off next week and worries about anti-speculative measures as well as deposit/lending rate hikes by the PBoC still lurking in the background, we could well see further profit-taking, especially given the huge amount of inflows that the Chinese bourse has seen in the past year and expensive P/E ratios. However, the economy’s fundamentals remain robust and after the profit-taking subsides, stability should return. Meanwhile, US lawmakers said on Wed that chances had improved this year for the US Congress to pass the Ryan-Hunter bill which would give American manufacturers a new tool to fight China’s exchange rate policy. However, an attorney for the China Currency Coalition has said that the Bush administration remains cool to the bill and that they didn’t really expect that they were going to endorse the legislation. Stay short the NDFs nevertheless in anticipation of a stepped up 7% p.a. pace of CNY appreciation which is not being priced in adequately yet.
In other words, the fundamentals are still the same fundamentals we saw a week ago: a burgeoning Chinese current account surplus expanding rapidly, and incipient protectionist pressure in the U.S. Hence, many eyes will still be trained on the trajectory of the Chinese yuan. As I’ve pointed out in other posts, the bilateral and the effective exchange rates can follow different paths — and it is the effective exchange rate that matters.
However, forecasts are made for bilateral rates, so I thought it would be useful to show the dispersion in predictions.
Figure 1: Log actual CNY/USD nominal exchange rates (blue, monthly average of daily rates), forecasts from FX Forecasts, dated 2/21 (red squares); Deutsche Bank forecasts dated 2/22 (green triangles); and forward rates (black +). Source: IMF, International Financial Statistics online, FX4casts.com, Consensus Forecasts and Analysis of Currencies (March 2007); and Deutsche Bank, Exchange Rate Perspectives (February 22).
Since the graph shows logged values, a constant rate of appreciation is depicted as a straight line. Forwards predict continued appreciation at the relatively rapid pace experienced in the past few months (although beware using forwards as predictors [pdf]); interestingly DB predicts a deceleration in appreciation, while the consensus from FX4casts is for even more deceleration.
However, there is wide dispersion of the forecasts. Figure 2 depicts the highest and lowest values at the borders of the 95 percent band.
Figure 2: Log actual CNY/USD nominal exchange rates (blue, monthly average of daily rates), forecasts from FX Forecasts, dated 2/21 (red squares), and low/hi (95%) forecasts; Source: IMF, International Financial Statistics online, FX4casts.com, Consensus Forecasts and Analysis of Currencies (March 2007).