G10 Currencies will be at the Mercy of China

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There’s a lot of economic data on the calendar this week from different parts of the world and while many of them are important, G10 currencies will be at the mercy of China. The U.S. Treasury was also supposed to kick things off Monday with its semi-annual report on exchange rates but on Friday, they said the report has been delayed because of the “need to assess progress following the G20 Finance Ministers and Central Bankers meeting on November 4th and 5th.” In reality, the Treasury doesn’t want to make China an issue ahead of the elections. While we are disappointed by this delay, the chance of China being branded a currency manipulator was extremely slim anyway. Despite all the kicking and screaming about China’s undervalued currency, the last time they were officially slapped with the label was in 1994.

Therefore G10 currencies will be much more affected by this week’s Chinese economic reports, which also happen to be the last set of economic data before the November 8th leadership change. We all know that the Chinese economy has been slowing and this week we will find out exactly how much. Since China has been the sole source of growth throughout the financial crisis and into Europe’s sovereign debt crisis, the simultaneous slowdown in China, U.S. and Europe has meant a slower recovery in countries around the world. How the Chinese economy is doing is almost just as important as how the U.S. and European economies are faring and for some countries, even more so.

Chinese Economy Expected to Grow at Slowest Pace in 10 Years

Risk appetite in the FX and equity markets have been hanging by a thread so if this week’s economic reports show that the Chinese economy performed worse than expected, the sell-off in global equities and high beta currencies could deepen. Trade, inflation, industrial production and retail sales figures are all scheduled for release this week but the most important report will be the quarterly GDP numbers. The Chinese economy is expected to have expanded by 7.4% in Q3, the slowest pace in more than a decade. In the event of even weaker GDP growth, the Australian and New Zealand dollars will be hit the hardest while the U.S. dollar and Japanese Yen will benefit significantly from safe haven demand. This means that bad Chinese data could drag all of the major currencies lower including EUR/USD, GBP/USD and USD/JPY.

There is not much room for an upside surprise since the Chinese economy grew by 7.6% in Q2 and if the data shows the economy growing at a faster pace, everyone will think that China is cooking the books. Nonetheless should the economy expand by 7.5% or better, we should see a relief rally in the FX and equity markets as investors and central bankers around the world breathe easier. More specifically, this means stronger Chinese economic data should drive currency pairs such as the AUD/USD, NZD/USD and EUR/USD higher as safe haven flows ease out of the U.S. dollar and Japanese Yen.

Will the Chinese Government Shore Up Confidence through Fiscal and Monetary Stimulus

The key question is whether the Chinese government will shore up confidence in the new leadership through a fresh round of fiscal and/or monetary stimulus. Given the concerns surrounding the new leader (such as his prior disappearance) and the market’s lackluster reaction to the government’s previous attempts to inject liquidity into the market, we believe there is a good chance of more stimulus after the November 8th leadership change. With 7 of the 9 ruling members retiring, this will be China’s most significant leadership change in more than a decade. While some people believe that there won’t be a big impact on the financial markets because the party remains the same, it could be a very prudent strategic move to announce a big stimulus program to show to the people that the new government is committed to the economy. More stimulus from China could be just what the market needs to reinvigorate the rally in equities and high beta G10 currencies.

Kathy Lien
Managing Director

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