EUR and CNH

Although yesterday's ECB meeting was never going to be in play, Mario Draghi was particularly circumspect, refusing to drop much of a hint about either an extension to the full size QE program or what a taper might look like.  (He did, however, concede that the program will need to be wound down via a taper rather than stopped cold turkey.)  Indeed, the only time he showed much conviction was in the disdain he expressed for the various "uninformed" sources stories that have emerged over the past couple of weeks.   It's an interesting contrast to the Trichet ECB, when hundreds of thousands of Euribor options would trade an hour or two before a "sources" story appeared on Market News, which in a stunning coincidence often pushed the options immediately into profit.

Anyhow, there was enough jiggery-pokery in the Q&A to ensure a torrid time for short term punters trying to trade the headlines.  ("No discussion of extension"....Bunds drop half a point.   "No discussion of a taper"....Bunds rally right back.)  Indeed, intraday price action in bonds has been erratic for several days now, which is probably good if you're a swing trader but less so if you're looking at them through a fundamental lens.   The same holds true for many markets at the moment, though you have to say that the euro is starting to look rather heavy.

After all, it remains one of the cheapest shorts against which to hold USD, certainly more so than the CNH.  As noted a few days ago, the chart of USD/CNH looks good for more upside....

...on a carry-adjusted basis it's been a difficult trade to hold for very long at all.

Indeed, this is the great conundrum with trading China....the line you see on your chart looks like an obvious trade, but once it's implemented and paid for, it's not nearly as good.   The chart below refreshes work from earlier in the year, illustrating the RMB vs CFETS basket (a home run short), the nominal version of a tradable version of the same (a stand up triple), the tradable basket with carry included (a double, assuming low transaction costs- ha ha ha), and the trade that people actually do, the CNH vs USD (grounding into a double play earlier this year, now just a fielder's choice.)

Now, Macro Man has contended that the despite the incipient hysteria over another round of Chinese currency depreciation, if anything the shift has been away from depreciation and towards stability on a basket basis, as you can see from the sideways tilt in the CFETS baskets in the chart above.  The upshot of this is CNH versus the USD is more aligned with movements in the basket constituents (the largest of which is the euro) that has historically been the case.  We can see this both on a naive overlay chart...

...and via statistics (the 60 day correlation has gone from 0.32 at the beginning of the year to 0.58 now.)  That's not to say the causality is all one way...after all, perceived weakness in the RMB can still force the PBOC to intervene, thus drawing down reserves and forcing rebalancing sales of EUR.

The moral of the story, however, is this:  what you are seeing in USD/CNY or CNH these days represents dollar strength more than it does RMB weakness.   And frankly, if you're going to play dollar strength....why not do it against the more liquid currency with the better carry characteristics (albeit without the Kyle Bass wishcast targets)?