USDCNY Battle

China used to not have to worry about its currency becoming too weak, as it had a hugely positive current account surplus and no worries about big capital outflows.  That started to change in 2015, and now it is a completely different story.  The PBOC has been able to be reckless with their monetary policy and pump up M2 to astronomical levels without worrying too much about inflation because of that huge current account surplus and strict capital controls.  Well, the capital controls have gotten even more strict under Xi, but that net inflow of dollars isn't there anymore.   That's why China's holdings of Treasuries has been going down over the last few years, and thus the tighter capital controls. 

Last 10 years:

Last 6 quarters:

The last 2 quarters has seen a net outflow of dollars from China, and that is what is preventing the PBOC from having even easier monetary policy, because of the yuan weakness.  In China, the supply of dollars is tight but the supply of yuan is plentiful.  That is why they have capital controls.  The only long term solution to relieve that pressure is to either have a tighter monetary policy or a weaker yuan.  They seem hell bent on keeping the USDCNY under 7, which will limit the amount of monetary stimulus they can provide.  Unless of course, they decide to sell more Treasuries, which will only make their FX buffer smaller for supporting their currency. 

I have seen a lot of articles about China intentionally letting the yuan weaken to support exporters because of the US tariffs.  No, they don't need to do anything and the yuan would have weakened naturally from 6.30 to 6.80 anyway, just because of their current economic weakness and the dollar outflows. 

Now you are seeing China try to support the yuan by making it harder for speculators to bet against it, but these are desperate measures that don't work in the long run.  They will need to sell dollars if they really want to support it, which is something they don't want to do because it sends a bad market signal, like 2015. 

This is worse than 2015 for China, and the market is acting like it isn't as bad as 2015.  Sure, the SPX has benefited from the big corporate tax cuts, and should be higher than it was in 2015, when it went down to 1840.  But the global economic situation, particularly China, is worse.  Right now, US market momentum from stock buybacks keeps the thing going, but if you remember in 2007, that was also a year when buybacks surged higher, and that was the top of a 4 year bull market. 

Wow, this SPX is like a zombie, it rises from the dead and keeps coming back.  Back on Thursday, we had a gap down, supposedly as trade war worries crept in, but that has all disappeared in a matter of 2 days, and we are back to the post US/EU deal euphoria levels from Thursday, July 26.  It is definitely tempting to add to the SPX short here, but the strength in Treasuries is holding me back.  If the SPX stays in a 2830-2850 range this week, I will probably add to the short.