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Shanghai. Intensifying US pressure on China’s currency regime may delay a rise in the yuan against the dollar but the eventual appreciation will be quicker than currently priced in by the offshore forwards market.

Dealers say investors should short offshore dollar/yuan non-deliverable forwards in the middle of the curve, especially benchmark one-year NDFs, while trimming such positions in the short-term NDFs.

“The Sino-US dispute over the value of the yuan will surely be counter-productive for a brief period, say for a few months,” said a senior dealer at a European bank in Shanghai.

“There will be no opportunities at the short end of the NDF curve, and speculators are bound to lose out after excessive speculation since the start of the year.”

Years of US grumbling over what it and others say is an artificially undervalued yuan reached a higher pitch last week when US President Barack Obama pressed China to move to a more market-oriented exchange rate in a speech that laid out a plan to boost US exports in coming years.

Chinese Premier Wen Jiabao hit back, denying that the yuan was undervalued and insisting that his government opposed mutual accusations and the use of coercion to force a country to raise its exchange rate.

Currency dealers in China believe the latest dispute has significantly increased the chances the US Treasury Department will label China a “currency manipulator” in a regular half-year review of trade partners’ currency practices, due on April 15.

Some dealers who trade on the Chinese market, the China Foreign Exchange Trade System, thought the likelihood of such a US move had greatly increased.

If labeled a manipulator, the United States could slap duties on a wide range of Chinese goods. US lawmakers are already threatening to slap duties on Chinese goods unless Beijing abandons its effective peg.

But such a designation is likely only to delay what dealers had thought might be a renewed willingness by China to let the yuan resume appreciating in the second quarter of this year.

They believe it would inflame a growing belief among the Chinese public and officials that the major developed economies, having secured China’s cooperation in stimulating the economy and getting past the worst of the financial crisis, are now intent on pursuing their own interests at China’s expense.

“The Chinese have a sort of feeling that the hunting dog is now being tied down because it has already caught the rabbit,” said a dealer at a Chinese commercial bank in Shenzhen.

“If the United States names China a currency manipulator, opposition from the grass roots up to senior officials will mount, even if the authorities want to let the yuan move more freely.”

Beijing allowed the yuan to appreciate about 20 percent on the dollar from its July 2005 revaluation until mid-2008, but has since re-pegged it within about a 100-pip range near 6.83 to the dollar, aiming to protect its exporters from the financial crisis.

The worsening yuan dispute has made it impossible for China to conduct a one-off yuan revaluation, dealers say, as the country would substantially lose face after the widely publicized US pressure and counter-statements by Chinese officials.

That would make the current market pricing of the yuan — at 6.8140 per dollar in one month’s time implied by one-month NDFs and 6.7881 in three-month forwards — over-valued.

If the rise in the yuan is delayed, Beijing will likely speed up the appreciation process once it does get under way, partly to offset rising inflation expectations and hot money inflows.

“Hedging or speculating, it’s now a good bet for about a 5 percent rise in the yuan against the dollar in a year’s time,” said a US bank dealer in Shanghai. “Trading NDFs of maturities near either side of one year would be more speculative but could still be a fair bet.”

A 5-percent yuan rise in a year would leave substantial room to short one-year NDFs, which were bid around 6.66 on Thursday, implying 12-month yuan appreciation of 2.5 percent, measured from the Chinese central bank’s daily mid-point.

China’s economy is expected to fully emerge from the shadows of the global financial crisis in the third or fourth quarter, with its exports recovered to the point they will no longer justify retaining a yuan peg to the dollar.

“China and the United States should be able to reach some compromises on the yuan sometime in the second half,” said the US bank dealer. “In any case, the two need each other in so many aspects they can’t keep confronting each other over the long term.”



Reuters