Despite the markets in China being closed for the Chinese New Year celebrations, China is still making the headlines after a report over the weekend showed that China’s foreign currency reserves dropped by nearly $100 billion in January. The report in itself provides clear evidence that the People’s Bank of China (PBoC) are intervening regularly in the markets in an attempt to boost the value of its own currency and selling dollars as the Chinese Yuan continues to face depreciation pressures with the currency recently falling to a five-year low. Concerns over slowing economic growth, capital outflows and the previous surprises from the PBoC to unexpectedly weaken the currency are all reasons behind the decline in the Yuan.
While some might look at the report and see that China still holds the world’s biggest reserve of foreign currency holdings at over $3.20 trillion as quite the ammunition to defend the currency, reserves have plunged by around $400 billion over the past six months and now stand at their lowest level since 2012. It is quite frankly unsustainable for the PBoC to continue defending the currency and spending their reserves at this speed, especially when you take into account that it was the shock devaluation by the PBoC last August that encouraged the Yuan to begin its steep decline in the first place. In my opinion the report spreads the idea that although the PBoC want to devalue their currency, the central bank only wants to do so at its own speed and this is not a sustainable approach when the economy is still under heavy pressure to liberalize its financial markets.
With economic data continuing to suggest that China economic growth will slow down to slightly above 6% in 2016 and if the previous stimulus measures do not begin to soon have a positive impact on China data, I believe that the Yuan will resume its decline with the USDCNY moving towards 7 later in the year.
European markets continue to fall
In spite of a more positive opening to trading for the week in Asia, following the absence of volatility in China as the markets close for the Chinese New Year period, European markets have continued to fall and it is currently expected that the US markets are likely to open significantly lower when trading commences later today. Investor sentiment is still being plagued by concerns over the speed of global growth, and I also believe that the equity markets are still struggling to accept that depressed oil prices are set to remain for a prolonged period, which in itself does threaten economies towards facing further inflation pressures and also lead those other economies that were reliant on commodity exports to enter a period of weaker economic growth.
WTI Oil continues to threaten a return below $30
Speaking of oil, WTI has continued to slip lower as trading for the week gets underway and this could be one of the reasons why equity markets around Europe are facing pressure. Regardless of any headlines circulating around a possible successful meeting between the Saudi Arabian and Venezuela oil ministers on how to stabilize the price of oil, elaboration is still required when it comes to what steps should be taken to achieve stability in the market. Talk around a possible production cut in the future is likely to persist, but onlookers need to realize that it is going to be very difficult to plan any production cut.
It needs to be remembered that it was previously a clear strategy of OPEC to regain market share by allowing the price of oil to continue drifting lower to hopefully squeeze away other producers in the longer-term, and the credibility of OPEC would risk being at risk if there was an unexpected production cut or the calling of an emergency meeting. It should also be remembered that there is an aggressive oversupply of oil in the market and unless an agreed potential production cut was over a couple of million barrels a day, it might not be enough to achieve a meaningful recovery in the price of oil.
Technically speaking, we still believe that the failure of WTI to close trading above $35 a week ago has left the commodity vulnerable to a heavy reversal of gains and we still think that we can fall back towards the milestone lows around $27. If WTI closes for trading today below $30, then I think the chances are certainly there that we are going to return towards the milestone lows over the next couple of days.
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