📝 Large CNH Adjustments Tend to Spill Over to EUR: J.P. Morgan FX Strategy

Focus on China has intensified as growth including credit cre- ation weakened further, PBoC unexpectedly cut rates and housing sector vulnerabilities were in the spotlight. As dis- cussed below, CNY weakness has more legs to it on policy and growth divergences. Housing sector vulnerabilities are likely to persist adding yet another source of differentiation, given the magnitude of leverage in non-financial corporates (note that Sweden is higher still; (Figure 4.) Debt servicing ratios are not at an extreme from a global standpoint for China but nonetheless still near its own two decade highs amid weak housing.

What has been notable for FX is that the euro bloc has been quite resilient to the recent CNY move, but we think this resilience is unlikely to persist if further CNY weak- ening were to occur. EUR and SEK are overshooting CNH by more than 1 sigma for instance Reasons for euro resilience are that negative data surprises are reducing in scope (albeit still negative) and EU real yields have kept pace with the US as discussed earlier. But this decoupling is unlikely to persist. Historically, large adjustments in CNH have tended to spillover into the euro even if euro valuations were cheap. For instance, prior to the 2015 CNY devaluation, euro had already weakened substantially vs. USD following ECB’s QE announcement under Draghi, yet EUR/USD wasn’t immune to CNY weakness (Figure 7.). - J.P. Morgan FX Strategy