Nudging China Toward Greater Financial Liberalization through the SDR

The IMF decided on 30 November 2015 to include China’s currency, the renminbi (RMB), in the elite basket of reserve currencies that determine the unit value of Special Drawing Rights (SDR). The IMF uses the SDR to supplement member states’ official reserves. Although the media has touted the inclusion of the RMB as a giant step forward for China’s international economic standing, its symbolism far outweighs the actual significance of the decision.

The Dollar Wins over the Euro and Yen

The US dollar will finish 2015 higher against both the euro and yen.  Sometimes those of us who follow the economic and financial news closely can be caught up with the short-term fluctuations.  As traders, that is what we do.  Investors, however, can take a longer look at developments. 

Taking a step back, we note that this is the fourth consecutive year that the yen has fallen against the dollar.  The greenback closed 2011 near JPY77.  It will likely finish this year near JPY120.  

The Renminbi-Dollar Complex

As China’s renminbi has been included in the IMF elite currencies and the Fed has started its rate hikes, conventional wisdom sees the RMB weakening and US dollar strengthening as simple long-term trends. The realities are far more complex, however.

Halfway to the (First) Holiday

The thinness of the order-driven capital markets is making price action that seems more inexplicable than usual.  The US dollar is mixed. It has recouped all the ground it lows against the euro yesterday, as the single currency briefly dipped below $1.09 in the North American morning.  It was unable to build on yesterday's gains that had carried it up to almost $1.0950.  Despite some fraying, the $1.08-$1.10 trading range still seems intact. 

Caution, Your Yuan Might Be Worth Less

Following the mini-devaluation in August, the yuan appreciated in September and October.  It began depreciating again in November and this has continued through the first half of December. 

The dollar finished the local session at new multi-year highs against the yuan.  Many observers see in the pre-weekend announcement about monitoring the yuan against a basket as an indication of the intentions of officials to push their currency down further against the dollar.

Dollar Status Ahead of the Fed

The US dollar turned in a mixed performance in the week following the ECB's surprise and the healthy US jobs report.  In some ways, the greenback was like a fulcrum, not the driver. 

The dollar-bloc currencies and the Norwegian krona were on one side, and the euro, Swiss franc, yen, and sterling were on the other.   The continued and sharp drop in energy prices and commodity prices more generally, coupled with risk-off impulses spurred by equity market declines, and year-end position adjustments were the main considerations.

Are Dollar Dominant Days Done?

The cat is finally out of the bag. The IMF has confirmed that the Chinese yuan will be included in the Special Drawing Rights (SDR) basket of reserve currencies. It was only a matter of time until the IMF acted on this, despite the considerable pressure exerted from the United States and other developed economies. The United States, and others, remained sceptical about the feasibility and durability of the Yuan in serving as one of the ‘elite’ reserve currencies owing to its inscrutable management in the past.

The CNY-CNH Gap is Widening

China’s instructions from the IMF were that, as an operational requirement for joining the SDR, the gap between the onshore and offshore yuan (CNY and CNH respectively) needs to close.  This was important for central banks to hedge.  The opposite is taking place. 

Driving the Euro-Dollar Exchange Rate

This remains one of my favorite Great Graphics that illustrate the divergence theme that I think is the main driver of the euro-dollar exchange rate.  Composed on Bloomberg, it shows two time series.  The first (white line) shows the German two-year yield minus the US two-year yield.  It bottomed near -80 bp in mid-October and slid persistently through last Wednesday to hit reach almost -138 bp. 

Need versus Want: A Yuan-inclusive SDR

Adding the renminbi in the IMF’s basket is the first step in opening up the world’s elite reserve currencies to emerging economies.

Currently, the International Monetary Fund’s (IMF’s) basket of major reserve currencies has only four members: the US dollar, the euro, the British pound and the Japanese yen. However, things are about to change now as the IMF’s Board has accepted the membership of China’s renminbi in its elite basket.