FxWirePro: PBoC’s Response to ‘Chinese FX Manipulator’ Label – Options Trade Strategies For Asian-FX Basket

President Donald Trump has recently Tweeted about a levy of 10% tariff on the consumer class goods being imported from China worth $300 Billion, which had largely remained unaffected by the trade war until now.

Consequently, to counter this development, the Chinese legislators and monetary authorities abstained Chinese firms from buying American agricultural goods that in-turn enabled their currency Yuan to depreciate to its lowest level since then. Hence, the U.S. Department of Treasury affirmed China as a ‘Currency Manipulator’.

Chinese yuan (CNY) has constantly been depreciating and CNY has dropped again this morning after the PBoC fixed the USDCNY very close to 7.00 (actual: 6.9996) handle this morning, reflecting the cautious mood among market investors. Larry Kudlow, the economic advisor for the White House, said that the US still wants to make a deal, but this should be a "good" one. “The reality is we would like to negotiate. We’re planning for the Chinese team to come here in September. Things could change with respect to the tariffs," said Mr. Kudlow. However, such rhetoric seems to be unable the ease the market fears on full-blown trade tensions.

In the meantime, the PBoC issued a statement in a response to the US' labeling China as "currency manipulator". The Chinese central bank said that the CNY depreciation is largely due to change of market conditions, and blamed that the US accusations are groundless. Most importantly, the state TV spent an unusually long time to report PBoC's statement, which suggests that China is taking a harder line in the trade tensions. As the risk of further escalation remains elevated, the market needs to be prepared for more turbulence.

While Indian Rupee (INR) is not a cheap currency, however, and subject to a central bank cap. The 36-country REER tracked by the RBI has risen 10% from 2018 lows, is 14% above long-run averages, and INR TWI screens moderately expensive vs. business cycle dynamics.

As a result, the hurdle for central bank permissiveness on rupee strength is high in the context of weak growth and limited counter-cyclical fiscal space. CNY/INR, in particular, is of policy interest given India's large bilateral trade deficit with China and the 4%+ fall in the cross since the re-ignition of trade conflict in May. INR may remain well supported as a carry currency in contrast to trade-exposed currencies of North Asia, but the scope for capital gains is muted.

The late-summer bullish seasonality of FX vol has returned with a vengeance after a hawkish Fed cut and unexpected resumption of trade hostilities. Contemplating the above factors, USD call spreads/digitals in CNH offer the best value as clean, defined premium expressions of escalation of the trade conflict. Alternatively, open a basket of long USD calls in North Asia financed by USD calls/INR puts as a relative value expression of North Asian FX underperformance vs. South Asian FX. Courtesy: JPM & Commerzbank