Fed cuts could send $1 trillion FX ‘avalanche’ to China, Jane says

According to Stephen Jane, the US cuts interest rates as Chinese companies may be tempted to sell $1 trillion in assets, a move that could strengthen the yuan by up to 10%.

The chief executive of Urizon SLJ Capital said the currency is now the biggest risk that markets are not pricing in correctly – and the yuan could play a big role.

“Think of an avalanche,” Jane said of the reflux effect. The yuan would “appreciate and possibly allow 5 to 10% would be modest and acceptable to China.”

The theory goes like this: Chinese companies may have made more than $2 trillion since the pandemic in offshore investments, parked in higher-rate yuan-denominated assets, according to Jane. When the Federal Reserve lowers borrowing costs, the appeal of dollar assets will decline and a potentially “conservative” $1 trillion flow back home as China’s rate discount with the US diminishes.

Jane, known for his work on the “dollar smile” theory, predicts that if US prices continue to cool, the Fed will cut rates more aggressively than markets expect. That, along with an overvalued greenback, America’s twin deficits and the prospect of a soft landing, are reinforcing his conviction that the dollar will fall.

The end result is a Chinese currency that may well march against the greenback. It traded around 7.12 per dollar in the onshore market on Monday, down from around 7.28 in July.

The rally could be bigger if the People’s Bank of China refrains from moving to increase dollar liquidity, London-based Jane said in an interview last week.

Fed Chair Jerome Powell said at the Jackson Hole Symposium on Friday that the US So the case for yuan gains now looks stronger as the time has come to cut its policy rate.

However, such a move is unlikely to happen immediately after the first Fed cut. That could happen when the dollar accelerates in a so-called soft landing scenario, or when inflation eases without triggering a recession in the US, Jain said.

Yuan pressure

His view aligns with Guan Tao, chief economist at Bank of China International Ltd., who argued that the risk to the yuan could increase if a scenario similar to the collapse of the yen carry trade were to emerge.

The fallout from the yen unwind was so big that it rippled through everything from stocks to credit and emerging currencies. A crash in yuan-funded carry trades — in which traders borrow the currency cheaply and sell it against higher-yielding options — could trigger new waves of panic, particularly across Asian markets.

Still, PBOC can iron out wild swings, that said. Beijing has always been wary of aggressive gains in the yuan because it could erode export competitiveness and undermine an already sluggish economic recovery.

China’s foreign exchange watchdog is already cautious as it gauges the impact of a stronger yuan on exporters, people familiar with the matter said. And some strategists have argued that carry trades around a weaker yuan make sense given China’s mixed economic fundamentals.

The PBOC also has plenty of measures to manage market expectations. Recently it has used tools to encourage currency stability, such as its daily reference rate for the onshore yuan and adjustments to the amount of foreign currency deposits banks hold as reserves.

Also, with the gap between Chinese and US yields remaining wide despite some gradual narrowing of late, corporates may not be able to sell off their foreign exchange holdings anytime soon.

Others estimate that China’s corporate cash holdings are somewhat lower than Jane’s.

Macquarie Group Ltd. estimates that Chinese exporters and multinationals have amassed holdings of more than $500 billion by 2022. Australia and New Zealand Banking Group Ltd. is valued at $430 billion.

“There will be pressure” on the yuan to rally, Jane said. “If we assume that half of this amount is ‘footloose’ and easily triggered by changing market conditions and policies, we are talking about $1 trillion in fast money that could be involved in such a potential stampede.”