patrick.net

So China's decided to let their currency (RMB) appreciate 2% against the dollar. And they've decided to re-peg it to a "basket" of international currency (Euro, Yen, Peso, etc.), instead of strictly against the U.S. dollar. Hmmm... what to make of these developments?

Given that China's central banks hold approx. $500 billion in U.S. Treasuries and MBS (Mortgage-Backed Securities), and --along with other asian neighbors who have large trade surpluses with us-- one would expect some impact on the U.S. mortgage market. Conventional wisdom holds that currency "diversification" basically translates as "fewer Yankee dollars". This would tend to throw cold water on demand for both the MBSs themselves (which directly reduces mortgage lending liquidity), and the 10-year Treasuries that fixed mortgage interest rates are tied to. This in turn means less credit for the mortgage market directly, and higher 10-year rates (which would be the Treasury market's logical response to a drop in demand).

On the other hand, you have the Renminbi's slight appreciation against the dollar, with the very possibility of more "adjustments" to come. This would seem to counteract the impact of the RMB's "basket" diversification on Treasury/MBS demand. After all, what is China likely to buy with that extra 2% (with more to come), but more Treasuries and MBSs? After all, they still have to find some way of spending/investing all those dollars they're getting from their most generous trading partner --Uncle Sam. Of course, if China allows its currency to appreciate more rapidly, this could put a damper on demand for Chinese goods by U.S. consumers, which in turn reduces the inflow of dollars (and China's appetite for dollar-denominated assets).

Does every action by the BoC have an equal and opposite reaction? Discuss...

HARM

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