China & The U.S. Dollar
The question is not how will China’s unpegging of their currency from the Greenback affect currency markets, but why did they do it?
If China expects the U.S. Dollar to continue to strengthen over the long-term it would make a lot of sense to decouple now. Under this scenario it would also make sense to continue to plow money into U.S. Treasuries — as they have over the last quarter. A strong U.S. currency decoupled from the yuan would be positive for China Inc’s enormous treasury balance while lending them more power to control their currency and not handcuff their exporters in an “iffy” economic climate – a win / win scenario. If they really thought dollar weakness were to occur and the global economy were to pick-up, decoupling would not make much sense. They would take a hit on their Treasury accounts — which are essentially too large to hedge –but their exporters would benefit — a lose / win scenario.
We will know shortly what will happen, and from a trader’s perspective I would be leery of putting too much stock in what the headlines and broker analysts are saying right now. I would be even more leery of getting attached to the opinion that this means the yuan will automatically increase in value over the intermediate and long-term.
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Jay Norris is the author of the best seller Mastering the Currency Market, McGraw-Hill, 2009, and a Senior Market Strategist with BrewerFX.com
To schedule a complimentary, interactive tutorial with Jay on determining market direction go to One on One Tutorial
DISCLAIMER: Forex (off-exchange foreign currency futures and options or FX) trading involves substantial risk of loss and is not suitable for every investor. Risks include the potential that changing political/economic conditions may substantially affect the price/liquidity of a currency. Investors may lose all or more than their original investments.