China to Put Renminbi in a Currency Basket

Things heated up in the currencies this weekend… Yes, while everyone was wiping the milk from their mouths from their cereal they ate for breakfast on Saturday morning, the Chinese made a BIG announcement… Rather than tell you in my own words… Here is the official statement from the People’s Bank of China (PBOC)…

“In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People’s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility.” (They say RMB for renminbi.)

So… After many months of having the renminbi pegged to the dollar (although it was not an official peg, it was a de-facto hedge), the PBOC will resume the ascent of the renminbi (CNY) versus the dollar that took place for three years after the “official peg” was dropped in July of 2005… But, the financial meltdown of August 2008 put a governor on the renminbi that has now been removed, per the statement from the PBOC.

The PBOC also said that the “new currency regime” would be to value the renminbi versus a basket of currencies (that’s how they did it 2005-2008), but this time they mentioned that they would allow the markets some say in the movement of the currency. Now… Please pay attention to what I’m about to say… There are a lot of people that believe that this will mean a HUGE one-way street for renminbi versus the dollar… I’m not one of those! While I think at the moment renminbi should move higher versus the dollar, there’s no “guarantee” that it will always move higher versus the dollar! The renminbi is now “flexible”!

So… How did the Asian and European markets react to the news when they opened overnight and this morning? Well… They like it! Especially the Aussie (AUD) and New Zealand dollars (NZD)…

OK… So… Remember when I said that I just didn’t believe that China’s economy was going to collapse like many so-called “experts” were saying? Listen… China would not have done this if their economy were on the edge of collapse! So… That sent a signal that it was “back to business” for these two South Pacific currencies.

The euro (EUR) traded all the way up to 1.2490 when the markets opened in Asia last night. But that euphoria faded and the euro is back to attempting to move past 1.24! The single unit tried three times last week, and was “shot down” April Wine style… But with this newly acquired appetite for risk that the markets now have, we just might see the single unit move past 1.24 and remain there for more than a couple of hours!

The Swiss franc (CHF) has returned to the 90-cent club, and the Canadian dollar/loonie (CAD) is pushing the envelope of parity once again!

There is a lot of “event risk” in the markets this week… By that I mean, we’ve got a Fed FOMC meeting, a Norges Bank (Norway) meeting, the UK will announce an emergency budget, and a G-20 meeting at the end of the week… Speaking of G-20… They won’t be able to point fingers at China this time!

There is some data to print this week… Home Sales data dominates here in the US. In Germany, there will be an IFO confidence printing, and in Canada, we’ll see CPI (consumer inflation)… This Canadian CPI report, I think, has the potential to be the straw that stirs the drink for the loonie… The Bank of Canada (BOC) next meets on July 20, and there won’t be any inflation data between this week and that meeting. So… A higher than expected CPI could lead the markets to believe the BOC would hike rates on July 20… And vice versa should the CPI be lower than expected…

Even if Canadian CPI is strong, I don’t believe it will be enough to move the BOC to hike rates. The BOC made it quite clear after becoming the first G-7 country to raise rates, that it was not going to be an aggressive rate hike cycle… But… Just because I believe that, doesn’t mean the markets will follow… I still think they will get all juiced up on a strong CPI.

Well… China’s announcement HAS to be a shot across the bows of US Treasuries… A stronger renminbi, means less currency reserves, which means less money that the Chinese will have to buy Treasuries… And the rot on the Treasuries’ vine is being exposed already, with the long bond down over 1 point overnight… And the 10-year? Well, last Friday it traded with a yield of 3.17%, today… It’s 3.28%…

Remember when I told every US Treasury Secretary and lawmaker that went to China and demanded that they allow more flexibility in their currency, that they should be careful what they wished for? Unintended consequences… And US Treasuries are going to see those unintended consequences up close and personal.

And gold… The price of gold is $1,260 this morning… WOW! I was told last week that there were quite a few trades at $1,255 to sell, a line of resistance, if you will… Looks like gold didn’t care too much about that line of resistance… There are some funny thoughts I had go through my mind about historic weak resistance lines, but those are better kept in my head!

With the renewed appetite for risk… The Japanese yen (JPY) doesn’t look so perky any longer. And in my mind, that’s exactly how it should be! Japan and the US are the two largest debtor nations on the planet…

And… With the renewed appetite for risk… The Brazilian real (BRL) is back in the driver’s seat… Sniff-N-The Tears style! The real has gained over 2% in the past 5 days, which nearly brings the real back to the same level it began as we turned the calendar on the year! And with the HUGE interest rate differential real enjoys, that’s manna from heaven for some investors!

Then there was this… (From the NY Times – which I despise – but that’s where the story was…

“Many states are acknowledging this year that they have promised pensions they cannot afford and are cutting once-sacrosanct benefits, to appease taxpayers and attack budget deficits.

“Illinois raised its retirement age to 67, the highest of any state, and capped public pensions at $106,800 a year. Arizona, New York, Missouri and Mississippi will make people work more years to earn pensions. Virginia is requiring employees to pay into the state pension fund for the first time. New Jersey will not give anyone pension credit unless they work at least 32 hours a week.”

But get this… “Nearly all of the cuts so far apply only to workers not yet hired. Though heralded as breakthrough reforms by state officials, the cuts phase in so slowly they are unlikely to save the weakest funds and keep them from running out of money.”

Hey! I don’t make this stuff up!

To recap… China made a HUGE announcement on Saturday, saying they would return to allowing the renminbi to be moved by the markets (to a degree) using a basket of currencies as their guide. This announcement has fired up the risk takers, and almost all currencies, save dollar and yen, are gaining ground this morning.

Chuck Butler
for The Daily Reckoning

The Daily Reckoning