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What Does a Weaker Yuan Mean for US Stocks?

June 27, 2023

From the Desk of Ian Culley @IanCulley

Most emerging market currencies have been in beast mode.

The Chinese yuan is a notable exception.

In fact, most Asian currencies haven’t fared well against the dollar over the trailing three months.

Latin American and Eastern European currencies – mainly the Brazilian real and the Mexican peso – are driving these markets.  

Analyzing these currencies through the Emerging Currency Fund $CEW as it makes new 52-week highs is useful.

But I’m more interested in the Chinese yuan as it slips and slides against the dollar.

Why? 

China represents the world’s second-largest economy.

And, based on the charts, the yuan could provide valuable insight into the direction of US stocks…

Check out the relationship of the US dollar to the offshore yuan, or the renminbi (USD/CNH):

The USD/CNH is the dollar pair traded in the open market. And it’s printing fresh six-month highs.

Not many global currencies allow the USD to make that claim.

I like the USD/CNH long toward 7.75 over longer time frames – but only if it trades above 7.19.

The currency trader in me always has to outline the risk levels and potential trade setups for those who participate in the forex markets (the most liquid markets in the world, by the way). 

But the implications of a sustained uptrend for the USD/CNH far exceed a mere trading opportunity.

Since the People’s Bank of China (PBOC) sets the exchange rate every morning, a rapidly depreciating yuan signals an attempt to dampen dwindling economic activity.

Global risk assets, including US stocks, often struggle as the PBOC devalues the yuan.

Here’s a chart of the yuan (CNY/USD) overlaid with the S&P 500 $SPY:

A steep devaluation in the yuan led the SPY lower in 2018 and 2022. Those recent events make it impossible to ignore its 28% decline since January.

Perhaps the yuan will dig in and reverse higher, supporting the breakout in US equities at the index level.

Or China’s economic outlook via the yuan is warning global investors of further downside action in the coming months.

To be clear, I’m bullish on US stocks. I find it hard not to be when industrial names and old economy stocks are showing signs of strength.

Regardless, I expect selling pressure to hit global risk assets, including the S&P 500, if the CNY undercuts its October 2022 pivot lows.

Is it more about the USD than the CNY? It’s possible.

The US Dollar Index $DXY is trading at the lower bounds of its year-to-date range.

A breakdown in DXY would mark a significant development for global equities, no doubt.

But I can’t avert my gaze from the yuan’s October lows (approximately 7.38 for USD/CNH) and what a breakdown could mean for the world’s second-largest economy.

Stay tuned!

Thanks for reading.

Let me know what you think. I love hearing from you!

And be sure to download this week’s Currency Report!

 

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