Whither the renminbi.
We have all learned to pay attention to the Chinese currency. Although it’s still closely managed, with capital flowing in and out far less easily than it does into other currencies, it’s clear that the exchange rate between the yuan and the U.S. dollar sets the terms of trade between the world’s two biggest economies. However, the yuan is largely seen as a derivative of the strength of the dollar, then massaged by the Chinese authorities, whose decisions are understood to have effects elsewhere.
But what if the arrow of causation points the other way? In other words, is the Chinese currency now sufficiently responsive to the rest of the world that we can treat it as a driver of events elsewhere, and not just an effect? Mansoor Mohi-uddin, the veteran foreign-exchange analyst who’s now the chief macro strategist for NatWest Markets, made that argument to me this week. It makes sense.
We have to proceed with caution here. China’s currency doesn’t reflect market forces in the way many others do. If you crave tight correlations, you won’t find them. But Mohi-uddin suggests looking at the broad turning points for the yuan against the dollar and comparing them with the turning points for the euro-dollar exchange rate. Here is the result of that exercise (with the euro inverted for clarity):
It does look as though there’s some information embedded in the yuan about how the dollar will move against other currencies, but I wouldn’t go much further than that. As Mohi-uddin puts it, the yuan “sends signals about what the U.S. dollar will be doing.”
He argues that since the U.S. trade deficit in goods is about $900 billion, and China accounts for about half the shortfall, moves in the yuan “tell us in real time whether the U.S. can fund its deficit with China at current exchange rates.” If the dollar strengthens, that signals the U.S. will be able to attract enough capital to finance its deficit. If it weakens, the U.S. will have trouble financing its deficit with the rest of the world.
Now look at the turning points since the shock yuan devaluation of 2015, which, among other things, ushered in a new era of flexibility for Chinese capital flows. The People’s Bank of China announced in May 2017 its countercyclical buffer, which was a signal that it wanted the yuan to strengthen while also making it easier for foreigners to buy bonds. This coincided with a turning point for the euro, which enjoyed a strong rally against the dollar for much of 2017. That weak dollar was, in turn, a crucial driver of the strong and stable returns that world markets generated that year.
Then in September 2017, China announced a rule to allow importers to buy dollars in the forward market, marking a significant relaxation of its measures against capital flight. That aided the dollar and coincided roughly with a turning point for the euro, which began to weaken.
Then came the U.S. tax cut at the end of 2017, which should have been immensely positive for the dollar — but the currency actually weakened a bit against the euro. This may have been partly because the persistent strength of the yuan showed that the U.S. was having trouble funding its deficit. But then China started a series of moves to weaken its currency and get credit flowing within the country. That unplugged the dollar, which rallied.
The most recent indications, according to Mohi-uddin, are that Chinese onshore banks are regaining confidence, and that external trade flows will recover because the Chinese-American trade dispute will be resolved and because the People’s Bank of China is stepping back from aggressive deleveraging. The long-term future for China’s currency, however, is not great. Any trade deal will entail that much more capital flowing out of the country, while the Chinese middle class’s growing demand for tourism could be a secular force to weaken the currency and therefore strengthen the dollar.
As trade talks between China and the U.S. resume this week, perhaps the bottom line is to be alert to all the effects a deal could have. A change in the terms of trade between these two countries can only affect everyone else.
Fed expectations come full circle.
Interest-rate expectations in the U.S. have executed a remarkably swift turn. This chart shows the implicit probability that the target federal funds rate will be higher at the end of this year than it is now, and the probability that it will be lower. As recently as November, at least one more rate hike from the Federal Reserve was almost entirely priced in by the futures market:
The fed funds futures market is therefore in alignment with the bond market, where declining yields and a flattening yield curve suggest a strong belief that the Fed will need to change course and cut rates. This implies great bearishness about the economy. It would be nice if they were wrong.
Ireland.
I am in London this week. Preparing from the safety of my home country for the next round of Brexit-ery in Parliament, I noticed something strange. The words “Ireland” and “Irish” were missing from all the main news broadcasts about Brexit on Monday night. As far as I can see, it is not due to come up in any of M.P.s’ votes tomorrow, although much remains unclear.
The Irish issue comes up a lot when discussing Brexit back home in New York. That makes sense because New York has a big Irish population. If Britain hadn’t signed up to the Good Friday Agreement, effectively committing itself to stay in the European Union so that the Northern Irish border could remain open, none of the current drama would be happening. Without the intractable issue of the Irish border, a deal to leave would have been thrashed out and approved by now.
The critical point that is being overlooked is that virtually any future arrangement that involves leaving the EU relies on the U.K. finding a way out of the Northern Irish border problem. The country’s historic commitments had, we can now see, effectively precluded it from leaving the EU in the way that many wanted. But Good Friday found a resolution to a dreadful and long-lasting issue that had caused much bloodshed. I doubt that it’s politically possible to reopen that agreement. But without some new accommodation with the Republic of Ireland and the communities in Northern Ireland, much discussion of Brexit seems pointless.
It looks as though many hard-line Brexiteers are deciding that they can, after all, put up with the deal signed by Prime Minister Theresa May, which keeps the open border. If they do not capitulate, however, it seems that there is little point in moving any further in negotiations among British politicians, or between Britain and the EU. The negotiations that need to happen involve the interested parties in Ireland. It’s embarrassing that so few people here seem to grasp that notion. Like Bloomberg's Points of Return? Subscribe for unlimited access to trusted, data-based journalism in 120 countries around the world and gain expert analysis from exclusive daily newsletters, The Bloomberg Open and The Bloomberg Close. | 
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