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The cost of the Sino-US FX deal: Surging money market rates (in Hong Kong)

This is from Financial Times’ FT Fast this morning:

A key lending rate between Hong Kong banks jumped to its highest level since February, potentially making it more expensive to short the renminbi.

The overnight CNH-Hong Kong Interbank Offer Rate (Hibor), a daily benchmark for offshore renminbi interbank lending, jumped to 5.446 per cent on Thursday – its highest level since February 19 – from 1.56767 per cent yesterday, write Peter Wells and Hudson Lockett.

Hong Kong banks do not rely on Hibor to anywhere near the same degree that global banks rely on Libor, the more famous US-dollar counterpart that is a crucial benchmark for loans that global lenders rely on for trillions of dollars of funding each day.

As such, the spike in CNH-Hibor has little practical impact on the banks themselves, but it has recently been viewed as more of a deterrent to speculators betting on CNH, the offshore renminbi.

On January 12, CNH-Hibor hit 66.815 per cent, the highest level since the benchmark was introduced in 2013, amid heavy speculation the People’s Bank of China, acting through state-owned banks, was soaking up liquidity to make the cost of shorting the renminbi more prohibitive as the currency came under pressure from speculators.

Ahead of this month’s G20 summit Commerzbank analyst Hao Zhou was among those predicting the PBoC would hold the line at Rmb6.7 against the dollar for a number of reasons, including a desire to facilitate special drawing rights (SDR) operations set to begin on October 1. However, he noted that “of course, politics tops the agenda again, especially as China is keen to show its ability to manage the whole economy and financial markets although the country still faces strong capital outflows.”

The central bank today weakened the currency’s midpoint fix for the first time since the end of G20, a move in line with analyst predictions that efforts to shore up the renminbi’s value would dissipate when the summit was over.

A spike in Hibor would track with a scenario in which the central bank either intervened itself or had mainland banks sop up liquidity on its behalf. It also has other options – as Commerzbank’s Zhou noted late last month: “We also expect that China’s central bank will allow the local banks to trade CNH in September, in order to narrow the CNY-CNH spread.”

This happens after China and the US over the weekend agreed to “refrain from competitive devaluations and not target exchange rates for competitive purposes”.

As my loyal readers know I am very critical about this deal (see my post on that topic here) as I believe that it is an attempt to quasi fix global exchange rates to avoid ‘currency war’ effectively limits the possibility for monetary easing – both in the US and China.

Ending China’s crawling devaluation will be bad news 

Since the Federal Reserve in December hiked the fed funds target rate the People Bank of China effective has tried to decouple Chinese monetary policy from US monetary policy by allowing a crawling devaluation of the Renminbi.

rmb-crawling-devaluation

This in my view has played a positive role in offsetting the negative impact of the Fed’s foolish attempt to tighten US monetary conditions.

However, the Sino-US ‘currency peace’ deal limits the PBoC’s possibility of continuing this policy and this is why HIBOR rates are now surging. This obviously is bad news for the Chinese economy – in fact it is bad news for the global economy and markets.

China does not need tighter monetary conditions. Chinese monetary conditions in my view is still quasi-deflationary and if the PBoC abandons its unannounced crawling devaluation policy it will cause a excessive tightening of Chinese monetary conditions, which could push back the Chinese economy towards recession.

It is too bad that policy makers from the ‘Global Monetary Superpowers’ believe that limiting currency flexibility is the right policy. Instead they should embrace floating exchange rates and instead focus on avoiding the biggest risk to the global economy – deflation.

 

 

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Kwanza devaluation is the right decision, but fundamental regime change is needed

This is from Reuters:

Angola’s central bank devalued the kwanza currency by about 6 percent against the dollar, a statement showed, a move analysts said was aimed at stimulating foreign currency inflows eroded by falling global oil prices.

 According to the bank’s latest update on the official exchange rate, issued late on Thursday, one U.S. dollar will now cost 116-117 kwanza, compared with 109-111 before.

The exchange rate is however much higher at 185-195 on a thriving informal market.

Plunging oil prices have hit Africa’s second largest crude exporter, forcing the central bank to restrict dollar sales as foreign exchange supplies dried up.

Analysts said the official devaluation would not be sufficient to shore up Angola’s foreign reserves.

I have long argued that Angola’s central bank would be forced to devalue it’s currency in response to the combination of falling oil prices and slowing Chinese growth – oil is Angola’s main export and China is both the biggest investor into Angola and the biggest importer of Angolan goods (oil).

This is what I wrote two years ago:

Hence Angola de facto operates a pegged exchange rate regime and it is pretty clear in my view that this regime is likely to exacerbate the negative impact from the ‘China shock’.

The China shock is likely to lead to depreciation pressures on the Angolan kwanza in two ways. First the drop in global oil prices is likely to push down Angolan export prices – more or less by a one-to-one ratio. Second, the expected drop in Chinese investment activity is likely to also reduce Chinese direct investments into Angola. The depreciation pressures could potentially become very significant. However, if the Angolan central bank tries to maintain a quasi-pegged exchange rate then these depreciation pressures will automatically translate into a significant monetary tightening. The right thing to do is therefore obvious to allow (if needed) the kwanza to depreciate to adjust to the shock.

What we have been seeing is effectively the petro-monetary transmission mechanism at work. Hence, given Angola’s dollar peg a drop in oil prices – and hence in Angolan export prices – has caused downward pressure kwanza and the Angolan central bank has tried to curb these depreciation pressures by tightening monetary conditions. However, the central bank has now rightly allowed the necessary devaluation of the kwanza.

However, the latest policy decision from the Angolan central bank – while warranted – is not enough. The decision is essentially a completely discretionary adjustment within the present regime. However, what Angola really needs is not discretionary adjustments of the exchange rate peg, but a rule-based monetary policy regime, which automatically adjusts monetary conditions to external shocks – such as a decline in global oil prices.

This is what I suggested back in 2013:

There are two ways of ensuring such depreciation. The first one is to simply to allow the kwanza to float freely. That however, would necessitate serious reforms to deepen the Angolan capital markets and the introduction of an nominal target – such as either an inflation target or an NGDP target. Even though financial markets reforms undoubtedly are warranted I have a hard time seeing that happening fast. Therefore, an alternative option – the introduction of a Export Price Norm (EPN) is – is clearly something the Angolan authorities should consider. What I call EPN Jeff Frankel originally termed Peg-the-Export-Price (PEP).

I have long been a proponent of the Export Price Norm for commodity exporting economies such as Russia, Australia or Angola (or Malaysia for that matter). The idea with EPN is that the commodity exporting economy pegs the currency to the price of the commodity it exports such as oil in the case of Angola. Alternatively the currency should be pegged to a basket of a foreign currency (for example the dollar) and the oil price. The advantage of EPN is that it will combine the advantages of both a floating exchange (an “automatic” adjustment to external shocks) and of a pegged exchange rate (a rule based monetary policy). Furthermore, for a country like Angola where nearly everything that is being produced in the country is exported the EPN will effectively be an quasi-NGDP target as export growth and aggregate demand growth (NGDP growth) will be extremely highly correlated. So by stabilizing the export price in local currency the central bank will effectively be stabilizing aggregate demand and NGDP.

Operationally it would be extremely simple for the Angolan central bank to implement an EPN regime as al it would take would be to target a basket of for example oil and US dollars, which would not be very different operationally than what it is already doing. Without having done the ‘math’ I would imagine that a 20% oil and 80% US dollar basket would be fitting. That would provide a lot of projection against the China shock.

So yes, the devaluation of the kwanza is the right policy decision right now and within the present (outdated) regime, but the Angolan authorities should as fast as policy move towards a entirely new monetary policy regime and my recommendation would certainly be to implement some variation of an Export Price Norm.

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See some of my older posts on EPN here:

Oil-exporters need to rethink their monetary policy regimes

The Colombian central bank should have a look at the Export Price Norm

Ukraine should adopt an ‘Export Price Norm’

The RBA just reminded us about the “Export Price Norm”

The “Export Price Norm” saved Australia from the Great Recession

Should small open economies peg the currency to export prices?

Angola should adopt an ‘Export-Price-Norm’ to escape the ‘China shock’

Commodity prices, currencies and monetary policy

Malaysia should peg the renggit to the price of rubber and natural gas

The Cedi Panic: When prayers don’t work you go for currency controls

A modest proposal for post-Chavez monetary reform in Venezuela

“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression

PEP, NGDPLT and (how to avoid) Russian monetary policy failure

Turning the Russian petro-monetary transmission mechanism upside-down

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

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