The CNY FX has started its celebration of the Chinese New Year early this year with a decent dip of the USDCNY pair towards the 6.92 - 6.93 handle while the CFETS TWI has rallied by an impressive 0.8% YTD.
On the back of its outperformance amid recent swings in risk sentiment and rising concerns over global geopolitical uncertainties, we note constructive equity inflows and suspected pickup in seasonal corporate dollar selling before the Lunar New Year as supportive factors.
The near-term outlook for the CNY FX is arguably a constructive one as the supportive factors outlined above are not easy to fade and the corporate dollar selling is expected to continue until the Chinese New Year. In a sense, the risks around the forecast bias in the short-run are skewed to the downside, meaning the USDCNY pair could sit comfortably below our 1Q forecast at 6.98.
Accordingly, we are positioned for any risks of lower USDCNY with 2M (14-Feb-20 expiry) 6.80 strike at-expiry digital USD put/CNH call.
With that said, our view on the CNY FX over the medium term remains a cautious one given limited prospects of a long-lasting trade truce coupled with domestic capital flow pressures.
CNY Bearish Scenarios:
1) Trade conflict with the US re-escalates;
2) Rebound in domestic growth is slower than expected;
CNY Bullish Scenarios:
1) Fiscal stimulus is stronger than expected;
2) Portfolio inflows strengthen further ;
OTC Outlook & Hedging Strategy:
Please be informed that the positively skewed IVs of 6m tenors still indicate the upside risks, they are still bids for OTM call strikes up to 7.08 levels.
Contemplating above factors, and organic depreciation pressures likely will take the pair back higher in 2H as domestic growth is expected to moderate and likelihood of further trade deals become difficult with the U.S. election cycle kicks in. Without any meaningful surprise to the scale of tariff rollback down the road, we struggle to see the case for the USDCNY to sustain notably lower than its current tariff neutral range at 6.95-7.20.
Hence, at this juncture, we uphold our shorts in CNH on hedging grounds via 5-month (7.00/7.15) debit call spread. If the scenario outlined above unfolds, we will re-assess our stance but at the moment there are no changes to our CNH recommendations. Courtesy: Sentry & JPM