Quick view: Chinese yuan depreciates to critical level against the US dollar

06/08/2019

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Charlie Awdry, China portfolio manager, provides his views on the central bank’s symbolic move to allow the yuan to weaken below 7.0 against the US dollar and its significance for investors.

This week the Chinese yuan (CNY) finally broke through to the downside to the psychologically important level of 7.0 to the US dollar. 7.0 was a clear line in the sand defended by monetary authorities in Beijing since late 2016. While we are not currency experts, we would not be surprised to see the yuan weaken further now that 7.0 has finally been breached.
 
Many will say this breach of 7.0 is a political decision as part of the US-China trade war but the economic theory of ‘the impossible trinity’ suggests that over the medium term, policymakers cannot simultaneously control domestic monetary conditions, the cross border movement of capital and the foreign exchange rate. The move shows that Chinese policymakers are finally giving in to this reality after a period of weak growth and ineffective policy responses. Perhaps it is merely convenient for the CNY to weaken through 7.0 now under the cover of the trade war?
 
The question of what this means for Chinese equity markets is a complex one to answer and is made more difficult by the extra market volatility brought about by lower trading activity in the Northern Hemisphere’s summer holiday month of August. That it is happening just as the political situation in Hong Kong is becoming more combustible is an extra cause for concern in what are traditionally very emotional Chinese equity markets.
 
We see the following implications:
 
1. Headwind for foreign investors

Chinese equities generally earn CNY profits and have balance sheets dominated by CNY assets so a weaker CNY is clearly a headwind to returns for overseas investors who think in terms of USD, euro or GBP. Emerging market/ Asia Pacific investors can choose between many countries to invest in and hence often look to the USD as a base for earnings across countries. A lower CNY will generally lead to lower earnings forecasts for Chinese corporates, a feature that investors tend not to like and that can keep equity markets cheap.
 
2. Offshore debt worries

We are extremely cautious on the equity of any company with offshore debt financing in USD and HK dollars. A particular concern to us is property equities because the sector is a very large issuer in the high yield offshore bond market. Funding CNY is cash consuming and generating businesses with USD debt is a problem if the CNY falls, as the effective debt load increases, and can cause solvency issues. Indeed, over the years, this has traditionally been the Archilles’ heel of corporate emerging markets.
 
3. Credit quality issues

As we have held a very cautious view on Chinese bank shares for over a year now, this CNY move reinforces our positioning with the potential for more credit quality issues. Credit quality issues originating from the property sector would not be a surprise but what is harder to determine are the unintended consequences of this move.
 
Conclusion
 
We will be monitoring the situation but it is probably fair to say that,  if corporate China has seen the People’s Bank of China (PBOC) defend 7.0 to the USD for almost three years, those same corporates will have implemented a view that the CNY will not fall below 7.0 in financial decision making. While offshore funding is one obvious exposure, we will be watching to see where else risks will emerge.
 
This CNY move can be considered as a policy stimulus to the Chinese economy at a time when economic momentum measured by the Caixin Purchasing Managers’ Index (PMI) survey has been weak. Given our China equity portfolios have a strong domestic demand focus, we will see if the currency move has a significant impact on consumer demand over time.
 
 
 
Glossary:
 
Offshore debt: bonds/debt issued outside the home country of the entity guaranteeing the bond.
 
Credit quality: used to judge the investment quality of a bond/debt. It is represented by a score assigned to a borrower, based on their creditworthiness. An entity issuing investment-grade bonds would typically have a higher credit rating than one issuing high-yield bonds.
 
Caixin Purchasing Managers' Index: a gauge of manufacturing activity focusing on small and medium-sized companies. Widely used as an indicator of the strength of the Chinese economy.   
 

 

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Issued by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier).

We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Past performance is not a guide to future performance. The performance data does not take into account the commissions and costs incurred on the issue and redemption of units. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change. If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

The Fund is a recognised collective investment scheme for the purpose of promotion into the United Kingdom. Potential investors in the United Kingdom are advised that all, or most, of the protections afforded by the United Kingdom regulatory system will not apply to an investment in the Fund and that compensation will not be available under the United Kingdom Financial Services Compensation Scheme.

Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. Key Investor document is also available in Spanish. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Singapore Representative Janus Henderson Investors (Singapore) Limited, 138 Market Street #34-03/04 CapitaGreen, Singapore 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent. RBC Investor Services Trust Hong Kong Limited, a subsidiary of the joint venture UK holding company RBC Investor Services Limited, 51/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong, Tel: +852 2978 5656 is the Fund’s Representative in Hong Kong.

Information on this document is on Janus Henderson Investors' best endeavours.

Specific risks

  • Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • Emerging markets are less established and more prone to political events than developed markets. This can mean both higher volatility and a greater risk of loss to the Fund than investing in more developed markets.
  • Changes in currency exchange rates may cause the value of your investment and any income from it to rise or fall.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

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