The Chinese yuan (CNY) has recently weakened against the U.S. dollar and other currencies as the dollar has remained stable. Further weakness in the CNY could lead to declines in the S&P 500, U.S. Treasury yields, and oil prices. The U.S. Federal Reserve faces challenges as raising interest rates could strengthen the dollar and weaken the CNY, negatively impacting the U.S. economy. Recent narrowing of interest rate spreads between Japan and the U.S. has also contributed to a weaker dollar. While China claims the CNY is referenced to a basket of currencies, the yuan appears to be managed primarily for its economic impact rather than any specific basket.

1. Concern About Markets in the Month of May
As CNY Weakens
The Chinese currency (CNY) inter-day, in dollar terms reached
maximum recent strength at 6.46 on March 21 and March 31. The
recent weakening from 6.462 to 6.490 in the first 10 days of April
occurred as the trade-weighted dollar was flat. Therefore, the CNY is
weakened against all other currencies at a time of a stable U.S. dollar.
Any strength in the dollar going forward accentuates the weakness in
CNY.

2. Why is this important? Weakness in CNY to or above 6.53 projects
a target CNY of 6.60, and, with a 30 day lag, a decline in the S&P
500 to its first quarter lows, a decline in the 10 year T-Note yield
toward 1.5%, and under $30 crude oil. The only counterbalance to
the Yuan weakness is a decline in the U.S. dollar below 94.5 toward
90.0 in the next few weeks.
The U.S. Federal Reserve is in a “box”, in that if the Fed talks higher
rates or increases the Fed Funds rate, the U.S. dollar strengthens
and the CNY weakens dramatically. The resulting impact is much
lower stock prices, lower yields on U.S. Treasuries, and lower oil
prices, not favorable to the U.S. economy.

3. What has occurred in the recent weeks of April is a significant narrowing
in the spread of real interest rates between Japan and the U.S. The
resulting 4% appreciation or stronger Yen created a weaker U.S. dollar
in the 93 to 94 range.
Zhou Xiaochuan, head of Chinese Central Bank, explained in a recent
news conference, that the Chinese Yuan change is referenced to a
basket of major currencies and other baskets. One can only conclude
the Yuan (CNY) is managed by the Chinese government for its
economic impact, and not by a specific basket. In the end, however,
the U.S. dollar is the most prominent member of any basket with a trade
deficit of $28.1 billion in February 2016, a substantial portion of the U.S.
total trade deficit.

4. The tug of war continues in April for a weak Yuan (CNY) to
stimulate growth and a stronger Japanese Yen (weak dollar) and
stronger CNY to compensate for narrowing real interest rate
spreads.
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