From the Desk of Ian Culley @IanCulley
The US dollar Index $DXY is trading at fresh highs. Take a look around the currency market. It shows.
Recent attempts to fade dollar strength have failed. The euro has fallen to its lowest level since late 2002. And we’re beginning to see forex pairs experience fresh breakouts in favor of the USD.
It’s certainly not the best look for risk assets. But it’s offering us great trading opportunities, not to mention some very valuable information.
A couple of pairs that are providing both are the USD/CNH and the USD/CNY. Let’s take a look!
First, we have a daily chart of the USD/CNH pair:
We’re starting with the offshore renminbi (CNH) because that’s what we actually trade.
It’s the form of the Chinese currency available to international foreign exchange and capital markets, unlike its onshore counterpart (CNY), which we’ll get to later.
On Monday, the USD/CNH took out a key retracement level as it reclaimed an area of former support turned resistance. Now that the path of least resistance leads higher, we want to get long.
We like buying any weakness back toward 6.86. But that’s our line in the sand. We’re long if and only if it’s above there with a target of 7.20.
But if we’re short the CNH, what does that say about the global economy?
I think it offers a great deal of information, given China is the world’s second-largest economy. But, before we go any further, I want to be clear: This is not “Ian’s Macro Corner.” There’s no grand thesis here.
Instead, I want to discuss the intermarket relationship between the Chinese yuan and stocks. We’ll get there.
The other major form of the renminbi is the onshore CNY, which is commonly referred to as the yuan. This is the currency that’s controlled by the People’s Bank of China (PBOC), which sets the exchange rate every morning.
That’s right. Every morning the PBOC decides the value of the yuan, and all trades within mainland China fall within a percentage or two of this reference rate.
As you can imagine, this gives the PBOC an incredible amount of power and influence, not just over the Chinese economy but the world at large.
It can devalue its currency on the spot or implement other quantitative easing measures to soften the impacts of an economic downturn.
And that’s what we’re really after: China’s economic outlook from an insider’s perspective. At the end of the day, that’s what the USD/CNY tells us. That’s the information we’re after.
If the Chinese economy is on the ropes, risk assets around the globe probably aren’t doing too well.
The overlay chart of the S&P 500 ETF $SPY and the USD/CNY pair tells the story:
Look at the 2021 rally. Stocks like it when the USD/CNY is falling.
As soon as this crucial currency pair began to bottom, stocks were rolling over to the downside. But the downside action for stocks really accelerated as the USD/CNY ripped higher.
That’s one of the last things stock market bulls want to see: a face-ripping rally in the USD/CNY.
Like interest rates, “slow and steady” is the best-case scenario for stocks.
Notice how the USD/CNY chopped sideways, coiling in a continuation pattern since May. Stocks flourished in this environment.
But now that the dollar is picking up steam against the yuan again, we’re wondering if stocks will react the same way when USD/CNY rallied this spring.
That would mean more selling pressure for stocks and risk assets in general. After all, it’s hard to imagine commodities trending higher if the yuan is showing significant weakness.
Of course, some of the downside pressure on risk assets can be attributed to US dollar strength. That’s fair, and I agree wholeheartedly.
Regardless, a strong rally in the USD/CNY pair would signal an economic contraction for the global behemoth whose expansion drove the last commodity supercycle.
We’ll be watching the yuan closely in the coming weeks and months. Stay tuned.
Thanks for reading.
As always, let us know what you think.
And be sure to download this week’s Currency Report!
Premium Members can log in to access our Weekly Currency Report. Please login or start your risk-free 30-day trial today.
Click here for our Weekly Currency Report.
Allstarcharts Team