Last week's GDP growth figures proved that US economic performance is still pretty mediocre, bordering on mildly tepid. While the Hawks were eyeing a 2.6% growth figure, actual GDP fell short of expectations and posted a rather dismal growth rate of 2.3% annualized.
Yesterday, we got the Fed's favorite inflation indicator, Core PCE, the inflation barometer that's extracted from the GDP release. And what we got was a dismal 1.3% inflation rate (YoY). This validated, once again, that the US economy failed to reach escape velocity that would necessitate several rate hikes a year. Rather, it suggested that anything beyond one or two rate hikes was unnecessary. Hardly a hawkish sign, yet Dollar demand keeps on rising while US yields move lower. It is this very combination that suggests that Dollar demand is being stirred by the demand of US Treasuries. Some say that this is investors moving into safety amid the rout in Chinese markets. Well, that's probably true, at least, in part. But the rest? There's a big bet on what China will do next.
China to Buy Dollars?
With foreign reserves that approximate the size of Germany's economy, China is one of the world's largest investors, if not the largest. With the exception of the US Treasury market, most markets aren't large enough to accommodate such a large mass of reserves. In fact, China is the largest foreign holder of US Treasuries with most of its foreign reserves invested there. Recently, I pointed out that Beijing might be forced to devalue the Yuan in order to ease pressures on the economy. That is what's needed to stabilize its exports and ensure the economy doesn't spin out of control. That analysis was on the Yuan side of the equation, but what's the other side?
Simply this: When China moves to devalue the Yuan it will do so by selling Yuan and buying, naturally, US Dollars. For two key reasons, this is really Beijing's only option. First, it is because the US holds a massive trade deficit with China. Second, the US bond market is the only market sufficiently large enough to allow China to effectively devalue the Yuan. If the situation in China continues to deteriorate the likelihood that the PBOC will devalue the Yuan will rise. Despite lackluster US data, the US Dollar could get a boost from China when the PBOC makes its move.
How to Validate the China Dollar Bet?
When will Beijing make a move on the Yuan and buy dollars? No one knows, despite the increasing probability that the Yuan devaluation is getting closer. But what is known is that if china's data continues to deteriorate, it will further reinforce that big bet out there that some time, maybe soon, China will start buying more Dollars. So while the Fed's next move and the performance of the US economy is the key for the Dollar, speculation on the Chinese Yuan may eventually be the first catalyst for the Dollar's break higher.
Look for my post next week.
INO.com Contributor - Forex
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.