It does not take advanced technical analysis to see the weakness of the US dollar. The fall from US$1.04 ($1.41) to US$0.93 over the past few months is noticed by everyone involved in international trade settled in US dollars.
Less noticed, however, is the behaviour of the Chinese yuan which has strengthened — moving from 7.1 to 6.7 to the US dollar over the same period.
China is keen for the yuan to become more widely used in global trade and investment. Take up accelerates when the renminbi is seen as a currency that foreigners can trust, first as a medium of exchange and secondly as a store of value.
The most recent Chinese bond issue was 2.7 times oversubscribed, suggesting that China has made considerable progress towards its international capital objectives. More remains to be done however, particularly in terms of currency flexibility. This is an open question and investors are closely watching this week’s Fifth Plenum for any confirmation of moves to increase the flexibility of the yuan.
The last change was in August 2014, when the yuan trading band limits were doubled from 1% to 2% either side of the official exchange rate fix. This was accompanied by a limited move towards a more flexible reference process in setting the fix.
The yuan was assessed against a basket of currencies, and this value was used to set the midpoint for the next day’s trade and hence the 2% trading band. This replicated the process used in the US dollar index (DXY), which references a basket of currencies.
But unlike the DXY index, the basket of currencies used to set the yuan midpoint fix remains unknown. However, the process sets a good base for further yuan flexibility.
After the 2014 move there was continued speculation the trading band would gradually further widen to 3%, then 4% with a longer-term aim of a free float.
This has not developed but recent comments by People’s Bank of China governor Yi Gang hinted that some widening of the band may be coming.
Speaking at a recent financial summit in Shanghai, Yi said the central bank will work to improve the yuan’s ‘‘flexibility’’ by reducing restrictions in the yuan’s use internationally. They will also work on improving the cross-border use of the yuan. The Chinese magazine Caixin also reports that he said the exchange rate should play a ‘‘better role’’ as an automatic stabiliser of the world’s second-largest economy.
This of course comes at a time when China is well advanced in the development and release of its DCEP sovereign digital currency. Increased flexibility is an inevitable consequence of any digital product as it is easily transmuted into a borderless currency.
Certainly, a long-term objective of the DCEP is to reach out as a trade enabler across the Belt and Road Initiative partners to help counter the weaponisation of the US dollar settlement system. It would be reasonable to anticipate that the physical Yuan would also inevitably move towards the same flexibility.
The embryo of these mechanisms is already in place. The midpoint fix is set with reference to the previous close determined by the market. The basket saw the yuan weaken beyond 7 against the US dollar. Some painted this as a currency manipulation in response to Trump’s trade wars. In fact, this reflected market response rather than a State direct response.
We see the same market-driven impact in recent months with the yuan rising to its highest level since mid-2018. This rise owes more to the markets’ recognition of China’s economic recovery than to State managed currency movements and that’s a significant change.
Just how far the Fifth Plenum will go in increasing currency flexibility remains an open question and investors are closely watching for an answer.
Technical outlook for the Shanghai market
The Shanghai index has moved below the lower edge of the long-term group of averages in the Guppy Multiple Moving Average (GMMA) indicator. This is often associated with a change in the trend direction. This trend change is confirmed when the long-term GMA compresses and also turns down. This has not yet developed.
Trend change confirmation also comes when the short-term GMMA moves completely below the long term GMMA. This also has not developed.
The Shanghai Index pullback has two support features and investors are watching for these support features to hold.
The first support feature is the value of the downtrend line B. The index may slide down this support feature until it encounters another support feature. The down sloping trend line shows levels of support that move consistently lower.
The horizontal support line near 3,220 defines an area where support is stronger and consistently has a single value. This support level has been successfully tested and acted as a support on four occasions since July 2020. This makes it quite a strong support feature, as this is a good probability the market slide down trend line B will find strong support near 3,220.
It is possible that the Shanghai Index is developing a broad consolidation pattern with resistance near 3,340 and support near 3,220. This is a very broad sideways trading pattern or trading band. The pattern is proved when the index again successfully tests 3,220 as a support area. This is the development traders watch for in the next week.
A successful test of support opens the opportunity for another rebound rally towards the upper edge of the trading band near 3,340. A weaker resistance level can be placed near 3,460 and this is near to the midpoint of the broad trading band. It is a minor resistance level for any short-term rally.
The depth of the main trading band consolidation is measured, and this value is used to set an upside breakout target. This is near 3,680. This analysis should be applied with caution as it is a long-term pattern development and target.
The evidence for the failure of this pattern is a sustained move below the support area near 3,210. Using the same trading band calculation method, this sets a downside target near 2,980.
Trades watch for support to hold and for a new rebound rally taking the index towards the previous rally high near 3,358.
Daryl Guppy is an international financial technical analysis expert and special consultant to Axicorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for two decades. Guppy appears regularly on CNBC Asia and is known as “The Chart Man”. He is a national board member of the Australia China Business Council.
