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Neal Kimberley
UK-based Neal Kimberley has been active in the financial markets since 1985. Having worked in sales and trading in the dealing rooms of major banks in London for many years, he moved to ThomsonReuters in 2009 to provide market analysis. He has been contributing to the Post since 2015 and writes about macroeconomics from a market perspective, with a particular emphasis on currencies and interest rates.
Tighter monetary policy has undoubtedly contributed to the easing of US consumer price inflation. But the improvement in supply chain flows as China’s economy gained traction also played a part, showing how intertwined the two economies are.
China is open for business again and seeking foreign investment. This means solid demand for the renminbi, even as the dollar softens with interest rate increases tapering off
China’s Covid-19 setbacks are temporary. Its reopening will boost demand for commodities, tourism and luxury goods, lift stock prices and support Asian currencies and economies, especially Hong Kong’s
Beijing recognises the need to allocate resources to cope with the current situation, but there also needs to be a parallel strategy to rekindle economic growth. The recent policy announcements are not by chance but are choreographed and intended to enhance China’s prospects once the health crisis is resolved.
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With Hong Kong’s monetary policy linked to that of the US, hopes of respite from higher prime rates in 2023 are doomed to disappointment. Despite expectations of policy easing, the Fed is solidifying its anti-inflation credentials as the influence of any central bank rests on its credibility.
As China moves away from its ‘zero-Covid’ policy, there is now a shift in narrative suggesting the move will also hurt prospects for its economy. This narrative ignores the many policy levers at Beijing’s disposal and assumes Beijing is not thinking through the change even though it has latecomer advantage.
The zero-Covid policy has weighed heavily on China’s economy, so shifting to pandemic management should give it a material boost. In addition to foreign demand for Chinese goods, reopening could unleash pent-up domestic consumer demand.
High-profile investors’ long record of failed attempts to break the Hong Kong dollar peg speaks to the strength of the architecture underpinning the scheme. Speculators might believe it is no longer fit for purpose, but their efforts are in vain unless they can outspend and outlast the HKMA.
The US Federal Reserve will continue to raise interest rates, even if it crimps economic activity, while China is easing some Covid measures. The prospect of the US economy slowing somewhat, while Chinese economic activity picks up, lends itself to a weaker greenback versus the yuan.
The sorry saga may prove an inflection point that results in investors demanding that cryptocurrency exchanges be headquartered in well-regulated jurisdictions with good governance – like Hong Kong.
Market talk that interest rates could peak soon is just talk. With US inflation still elevated and the jobs market holding up, the Fed has no reason to stop the hikes. Even if it is closer to the end of its hiking cycle than it is to the beginning, it is likely it would want to linger at the top of its hiking cycle before it starts to cut rates.
The Japanese yen falls to a three-decade low, while US inflation-fighting policy is likely to keep the dollar’s value high for some time. China’s policymakers must decide whether to restore the yuan’s competitiveness against the yen or ensure that dollar-priced goods remain affordable.
Washington is unmoved by the unease around the world at the US dollar’s appreciation because the currency’s strength is in the country’s interest for now. Until the markets see an end to interest rate increases or shifts in US policy, they will expect the dollar to get more expensive and act accordingly.
Hong Kong’s Linked Exchange Rate System shields it from US dollar strength, while China has taken several steps to ensure yuan stability. While other countries’ currencies are left exposed, these measures give Hong Kong and China protection against unconstrained US dollar volatility.
Hong Kong’s dollar peg means it must mirror US monetary policy, and the heavy lifting of supporting the local economy is left to fiscal measures. In Japan, a BOJ fighting to keep interest rates ultra accommodative is working at cross purposes with government officials trying to prop up the plunging yen.
Just as the pound plunged on the weak UK mini-budget, the yuan narrative is changing as Chinese authorities signal firm support for the economy and the yuan. Once traders sense yuan weakness is running its course, there could be an avalanche of dollar selling.
Current upward pressure on the US dollar-yuan exchange rate is essentially a function of greenback strength, not renminbi weakness. The real challenge will be if market sentiment starts to incorporate a bearish view on the yuan, as it has with the Japanese yen.
When the US dollar surges on the foreign exchanges, as it is now, the Hong Kong dollar also gains in value against other major currencies. This strength spells opportunity for Hong Kong investors who want to diversify their portfolios abroad.
Asian central banks facing currency weakness are stuck with no good moves as the Fed presses forward with interest rate increases and quantitative tightening. China’s central bank might be limited to managing the rate of descent of the yuan versus the US currency.
Germany has long been the engine of European growth and the German model rests on trade surpluses and factories powered by Russian energy. With electricity prices going through the roof and euro weakness making imported energy more expensive, the situation in Germany is alarming.
Japan, which has been trying to raise the inflation rate for decades, is sticking to an ultra-loose monetary policy in the face of US hawkishness. In China, such an approach carries the risk of rising capital outflows, renewed depreciation of the yuan versus the US dollar and unwanted inflation.
With inflation still well above the Fed’s target, more rate increases are on the cards, and the Hong Kong Monetary Authority is sure to follow suit.
Energy production constraints and increased winter demand mean it’s not just the price but the access to energy that policymakers need to consider. The move away from fossil fuels in the fight against climate change comes with costs which current circumstances are only exacerbating.
Investors may be mistaken in betting that China’s growth will continue to slow as policymakers focus on containing Covid-19. And they are almost certainly wrong that a monetary policy U-turn is coming in the US.
Although it’s looking increasingly unlikely that China will hit its 2022 growth target, Beijing is determined not to resort to aggressive stimulus. Youth unemployment, the Henan banking scandal, property sector weakness, and China’s Belt and Road Initiative lending are all pressure points.
For China, a stable yuan, particularly in the face of a rising US dollar, is an important symbol of market confidence in its financial system. Now, though, the banking crisis in Henan, where billions in deposits have gone missing, could shake investor faith and drag down the yuan if Beijing does not act swiftly.
Robust US jobs and average hourly earnings data suggest the Federal Reserve has ample room and every reason to keep raising interest rates. Meanwhile, China’s infrastructure focus is expected to give strong support to commodity prices and market sentiment.
The Chinese economy is showing signs of recovery and inflation isn’t a problem for the country’s central bank, unlike in the US and Europe. Given the centrality of the US dollar to the global economy, however, foreign investors buying Chinese assets need to evaluate the likely trajectories of both the yuan and dollar.
Downward moves in stock prices have made price-to-earnings ratios look more realistic, but the Fed’s efforts to curb inflation may not yet be reflected in lower earnings. Meanwhile, China’s persistence with its zero-Covid policy calls into question its GDP growth goal.
Comparisons between circumstances today and the run-up to the Asian financial crisis of 1997 should not be overemphasised. However, a combination of aggressive Fed tightening, a potentially even stronger dollar and pronounced yen weakness could prove problematic for those carrying US dollar-denominated debt.
