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Market impact of rising Yuan

WSJ had a very nice analysis on the potential impact of a rising Yuan. Nobody will know how much the appreciation will be, 3%, 5%, or 10%?  Will it be gradual or one-step revaluation?

But rising Yuan will make imports into China cheaper, increasing domestic demand for imported goods, especially energy and commodities.  Also, an appreciation of Yuan means relative devaluation of the US dollar, which is also good for commodity prices – there is a very strong correlation between falling dollar and commodity price, including gold.

Another impact could be negative on US treasuries.  According to the analysis, “Ripples from the currency markets could spread to U.S. Treasurys, as Chinese and other Asian governments, with fewer dollars on their hands, buy fewer U.S. Treasurys. Worries of reduced demand from China could result in a short-term selloff, …In 2005, 10-year Treasury yields jumped from 4.17% to 4.41% in the 14 days after the July revaluation. And from August through December of that year, China’s net purchases of Treasurys slowed to a monthly average of $2.7 billion, from $10.5 billion in the previous seven months, according to Treasury Department data.”

On the timing of the revaluation, the Journal points out that Chinese policy makers will avoid appreciation close to US’ mid-term election,  in order not to leave impression that they bow to the US pressure.  So a reasonable estimate is China will probably re-valuate between May and September — my own guess.

When China allowed the yuan to rise in 2005, it startled investors and sent waves through the financial markets. This time around a revaluation is widely expected. So will a higher yuan turn out to be a big yawn?

[ABREAST]

Not necessarily. Based on the experience of 2005, a rising yuan could boost other Asian currencies, lift commodity prices and hurt U.S. Treasurys. Domestic-focused Chinese stocks are also likely to rise. With China being an even bigger economic force throughout the global economy, sucking up commodities and dominating exports, the market effects could be bigger this time around. While some market moves have begun in anticipation of a policy change—oil prices are up and Asian currencies are rising—some analysts believe the market may be underestimating the size of any revaluation, leaving open the chance of a bigger-than-expected reaction when a change comes.

The currency markets have for months expected the Chinese currency to rise a bit more than 3% this year. That would take the dollar down to roughly 6.60 yuan from 6.80 yuan, where it has been pegged since 2008. At that time the financial crisis prompted China to put a halt to the gradual, 21% appreciation allowed since July 2005. But analysts at Morgan Stanley believe China could drive the yuan up 4% to 5% in several steps in 2010, and take the yuan to 6.17 by the end of 2011. Barclays Capital analysts also expect a gradual 5% increase this year. So far, the markets are betting on China making a gradual and modest move. … full text here.

Expectation of currency appreciation drives up China’s Hot Money

China’s foreign exchange reserves rose substantially despite its trade deficits.   Imagine how many people or investors are moving their money into China to bet on an incoming (and continuous) Yuan appreciation.

This is part of reason that caused Japan’s real estate bubble.

The ‘blame China’ game

Interview of Stephen Roach on ‘don’t blame China for US problems’, and prospect on China’s currency reform.