China Helps Yen But Hurts Commodity Currencies. By Nicholas Hastings

China's influence on currency markets may not be quite as direct as expected.

Instead, Beijing's policies are acting more like shadow puppets in the background, likely increasing support for the yen but undermining the outlook for commodity currencies.

The country's decision to release its yuan peg against the dollar last month for the first time since 2008 was certainly momentous. However, the subsequent rise in the yuan has been much more gradual than the market anticipated, with the Peoples' Bank of China still anxious not to move too fast.

See the dollar's fall against the yuan since the peg was released:



Click Image to Enlarge


This is hardly surprising given recent economic data suggesting that Chinese growth is starting to slow down. Further negative figures on the economy are expected next week.

But, while this is a reflection of attempts to cool the country's overheated property, Beijing appears eager to rebalance the economy at the same time, announcing plans to invest $100 billion in 23 priority projects in western China this year.

So with inflation recently rising over the PBOC's 3% target and with GDP growth still expected to clock up as much as 9.5% this year, the yuan will probably continue rising at its recent gradual pace. Since the peg was released the dollar has fallen to CNY6.7781 on Wednesday from CNY6.8275.

Even if the PBOC wishes to slow the yuan's rise even more, upward pressures on the currency are likely to remain given the balance of payments surplus that China runs with the rest of the world.

On the margin, this should be good news for the yen.

A stronger yuan makes China's goods less competitive in Asia and should only prove a plus for Japan, where export growth remains the primary engine of recovery.

There is also the increased interest in Japan from Chinese investors, with recent figures showing that China bought Y541 billion of short-term Japanese government bonds in the January-to-April period after largely ignoring the market for five years.

The impact on commodity currencies, however, should be more negative in the near term as slower growth in the property market takes its toll and the resulting slowdown in the global recovery as a whole dampens world trade in general and demand for commodities in particular.

Elsewhere, China appears keen not to rock the boat.

On Wednesday, the State Administration of Foreign Exchange not only reassured markets that U.S. Treasurys will remain an important market but that the euro zone also remains key despite the recent sovereign debt crisis.

"Europe was, is, and will be one of the major investment markets for China's foreign exchange reserves," SAFE said, referring to the more than $2.4 trillion that it has at its disposal.

Early Thursday in Europe, improved risk sentiment helped to dampen recent interest in the yen, with the euro pushing to a new seven-week high of $1.2688 against the dollar.

An upbeat global assessment from the International Monetary Fund, higher-than-expected employment in Australia and some optimism about the stress tests that will be given to major European banks all helped to lift investor confidence, with Nikkei following the Dow Jones Industrial Average's strong 2.8% rally with its own 2.8% rise.

By 0645 GMT, the euro was up at $1.2658 from $1.2648 late Wednesday in New York, according to EBS. It also rose to Y111.91 from Y110.93.

The dollar also rose to Y88.39 from Y87.70, while the Australian dollar made it up to $0.8769 from $0.8747.