The three whales of the last week: China, Greece, FRS

The fixed rate of yuan to dollar is the counterpart of EUR/CHF pair, broken in January by the same forceful decision
Even high mountains will not keep clouds - says a Chinese proverb. The Chinese Central Bank decided to devalue the yuan and liberalize the currency regime, which caused a downfall of many markets and emergence of the idea of new currency wars. The strongest economy with tough rate regulation is the nonsense of the modern market theory. The rate of the national currency must be set by the market, and China, again, pretends that it follows it. In fact, there is not trace of market in the actions of the Chinese Central Bank; that is a discretionary state decision; moreover, those steps were called temporary preventative measures against upcoming steps to be made by FRS and other central banks.

The fixed rate of yuan to dollar is the counterpart of EUR/CHF pair, broken in January by the same forceful decision. Yuan has been growing since the middle of 2014 along with dollar and brought the competitive ability of Chinese goods to a critically low level. China constantly seeks for balance between export and import prices. So, if there is a need, they will go down more along with the rates, and no one will prevent China from doing it. That will be especially the case, if prices for raw materials go up. The official reason for devaluation by 1.90% was a critical decline of exports (8.3%). Analysts include two more factors: the global decline of Asian stock market and Chinese attempts to meet the IMF demands to include yuan in special drawing rights. As of today, China has generated not only a strong wave on financial markets, but also additional difficulties for FRS to raise rates. Cheapening of yuan will lead to a larger decline of American exports, and, in the mid-term perspective, to pressure on inflation and stock assets. Last week, the market value of yuan fell by 4.7%. Possibly, it will be enough for China for gradual recovery. Investors think that the first stage of devaluation is over, the next will be possible not earlier than next year.

In essence, there is no real progress in the Greek issue. The nominal write-off of the Greek debt is forbidden by the EU rules; the thing that remains is reduction of amount by way of decrease of loan rates and extension of loan period. Exhausted Eurogroup, finally, approved the third aid program for Greece in the amount of 86 billion euros, the first tranche of 26 billion of which 13 will arrive on August 20, 10 billion for recapitalization of Greek banks (to the account in Luxemburg with accommodation in a special form), 3 billion will be waiting for their turn until September, according to the results of reforms and, possibly, elections. Tsipras does not have a vote of confidence in his government yet. Germany will have a vote regarding that program on Wednesday morning. There is an opinion that IMF will still join the third aid program for Greece - at least, European stocks stopped their decline based on those rumors, euro slightly dropped on Monday. The saga that Greece will pay another loan without paying off previous ones has been extended until October.

The FRS Protocol as of July 29 published on this Wednesday has been seriously outdated. Having discussions about rates, FRS members obviously missed several moments:
- Serious fall of oil prices and some more unfavorable predictions;
- Alternative data on labor market have shown reduction of recovery rate;
- Retail sales and industrial production are better than expected, and the US GDP for the 2nd quarter was revised with a rise to 2.9%;
- The growth of reserves and revision of GDP growth prediction for the 3rd quarter went down to 0.7%.

Those risks were not included in the Protocol, and its text may look too "bullish"; therefore, its impact on the market will not be lasting. If the text obviously requires strong data also for labor market and for inflation, the market will interpret that as low probability of raise in September. Regarding the dates of raise, there is a strong discrepancy between the expectations of economists and large market participants - market opinions are much more conservative and quite allow for the rate to remain the same this year. If FRS doubts align with the market opinion, the market will fall abruptly and with no pullback. If there is obvious confidence in raise in the next round, the growth will be abrupt with the following pullback approximately by 50% and further flat until new statistical data are released.

Due to continuing influence of yuan, it is worthwhile to analyze USD/JPY pair: the ceiling was reached in zone 124.50, and the pair can easily go down further; however, if there is little positive in the American data, it can penetrate 123.80 in case of turnaround with the target 123.20. Resistances: 125.82/125.37/124.95/124.62; supports: 124.10/123.82/123.53/123.30. Strong bids have approached 124.00.

Last week's demand for EUR/USD was caused not by Greece but rather by three other reasons: devaluation of yuan and yen, turnaround of the global carry trade, and SNB interventions to purchase of EUR/CHF. Euro was steadfast against dollar and closed the week over 1.1100. Now, EUR is risking to become the main failure. Strong support at 1.1040/1.0950/1.0890, resistances at 1.1215/1.1278/1.1365. In order to have a chance of growth to 1.1500, it is necessary to overcome a strong aggregation of orders at 1.1280. Further sale offers will be possible between 1.1140/60.

Author: Navsher Bartash,
ForexChief Currency strategist