FXStreet (Barcelona) – Strategists at BofA-Merrill Lynch, view that the Chinese equity sell-off might lead the PBoC to ease further, which might result in additional capital outflows from the economy.
Key Quotes
“The massive drop in SHCOMP undoubtedly affects risk appetite in the Asian equity space. However, compared to the dramatic jump in Chinese equity volatility, USD/CNY has remained very stable. Long-end fwd points have, however, risen considerably. FX implied vols have only started to tick up higher after collapsing to record lows.”
“In our view, USD/CNY volatility has collapsed only because PBOC wants it that way. This is evident from the fact daily fixing has not deviated from 6.15 (the middle of the recent range) by more than 0.5% since May. We believe that this might be because of two reasons: (1) Beijing’s desire of having RMB included in the IMF’s SDR basket as soon as possible, and (2) keeping the CNY stable to prevent further contagion especially when perceived external and internal risks are at elevated levels.”
“Further equity correction is likely to force China to ease monetary policy further. In doing so, China is likely to see increased capital outflows, especially when capital account is liberalized. Given FX intervention will lead to tighter liquidity conditions, PBOC will have to let go of the currency. This is precisely why we see 5-10% depreciation of CNY against USD over the next 1y. We are positioned long 3M USD call, CNH put spread 6.25/6.34 at a 0.29bp premium (current 0.12%).”
“We think current levels of outright forwards and implied vols are attractive enough to enter trades that are short CNH and long CNH vol. We are also received 5y CNY NDIRS against 5y USD IRS (currently 80bp).”
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