The Chinese Yuan, which was depreciating since August 2015, strengthened against the US dollar to hit a high of 6.4919 on February 15, 2016, easing fears of deflation in the global economy. The main reason for the USDCNH pair to decline was the higher reference rate set by the PBoC (People’s Bank of China). The PBoC allows a fluctuation between +2% and -2% around the reference rate. The gain of 1% seen in mid-February was the highest since 2005.
In an interview to China’s financial magazine Caixin, the PBoC’s governor Zhou Xiaochuan stated that there is no basis for the Yuan to keep declining against the US dollar and China would do everything to maintain a stable exchange rate against a basket of currencies while allowing greater volatility against the US dollar. The statement also provided a positive bias for the Yuan in mid-February. However, the Yuan was unable to maintain its strength against the US dollar. In less than a week’s time, the USDCNH pair reversed the trend to touch 6.54.
Considering the economic slowdown, it is but natural for the traders to short the Yuan. In order to prevent the Yuan from declining sharply, the Chinese central bank resorted to the purchase of the Yuan in the currency market. The net effect was a decline in the country’s US dollar reserves. From a high of about $4 trillion in 2014, the country’s exchange reserves had fallen to $3.2 trillion as of February 2016. The fast depletion of the foreign exchange reserves continues to impact negatively on the Yuan exchange rate.
As China shifts from manufacturing to a consumer-oriented economy, the capital inflows have taken a hit. In 2015, the emerging economies saw a capital outflow of $735 billion out of which $676 billion is from China. The country also experiences a massive credit contraction. Furthermore, the banking system is also heavily indebted.
The non-performing loans are expected to be about 10% of the $34.5 trillion in assets of the Chinese banks. To re-capitalize the banking system, major think tanks believe that the Chinese government may be forced to print as much as $10 trillion. This is expected to weaken Yuan further.
The exports, which form the backbone of the Chinese economy, declined 11.2% in January when compared to the prior year’s corresponding period. Another important point to note is that big players, including George Soros, hold sizeable short positions against the Yuan. Thus, considering all these factors, fundamentally, we can expect the Yuan to decline further.
Technically, as shown in the image below, the USDCNH pair has firm support at 6.53629. Minor resistance exists at 6.57660. The pair trades above the 50-day moving average. The pair is expected to touch a high of 6.6340 levels in a short span of time.
Thus, a forex trader should take a long position in the USDCNH pair at 6.5350 levels with a stop loss below 6.5220. The target for the trade is 6.6300. The risk to reward ratio is about 1:9.
A binary options trader should purchase a call option contract with April expiry. The suggested strike price for the call option contract is 6.5700.
Disclaimer: Any financial trading analysis offered here is our opinion and is not intended as advice or direction for investors. We cannot guarantee the success of any trades made as a consequence of this article, and we encourage traders to incorporate a strong money management strategy to limit losses when they enter the markets. Please use this article as part of your own research before formulating strategies prior to trading.
