There is a pattern in the following smattering of forex soundbites: “It feels like we’re already in the summer doldrums;” “[We] are moving into summer trading;” “We are in a summer period.” From three different analysts, three identical conclusions- summer has arrived.  Granted, summer officially began on June 21, but given all that’s transpired since last summer, I think we can excuse investors from delaying their summer vacations this time around by a few weeks, until the kickoff of second quarter earnings season.

Summer usually means a couple things for the financial markets: less liquidity/volume and less fluctuations. The decline in volume is largely self-explanatory, due to what can best be summarized as more play and less work. The decline in volatility is due to a different, but related cause, which is a delay in important investment decisions until the fall, when traders return to their desks and resume monitoring the markets full-time. Both phenomena tend to cause asset prices to move sideways.

This is especially true for forex markets. “Traders noted major currency pairs remain largely range-bound…Markets for now are hung up by uncertainty over the shape of any future economic recovery, he said. Economic data at this point ‘can be spun either way,’ likely leaving currency markets next week to key off of any earnings surprises from U.S. companies,” observed one analyst. As far as the decline in volume is concerned, “Emerging markets are becoming particularly volatile as liquidity declines over the summer period,” and “Bid-offer spreads are quite wide.”

Kathy Lien, of Forex 360, has observed another summer trend: “Over the past 10 years, the Canadian, Australian and New Zealand dollars have seen their steepest slides in the month of July. In addition, we have seen the U.S. dollar outperform the Canadian and New Zealand dollars 8 out of the past 10 years during this month.” This could be a byproduct of delayed allocation, as investors shift capital out of risky markets/positions/currencies. The lesson might be to stick to the majors.

Based on all current indications, this summer will be no exception to this rule. While investors have certainly grown more complacent about risk over the last few months, there is a lingering uncertainty. “Economic data at this point ‘can be spun either way,’ likely leaving currency markets next week to key off of any earnings surprises from U.S. companies.” Even with across-the-board positive earnings results, investors will likely remain wary and could hold off on taking any risky (overseas) positions until the fall.

There is a pattern in the following smattering of forex soundbites: “It feels like we’re already in the summer doldrums;” “[We] are moving into summer trading;” “We are in a summer period.” From three different analysts, three identical conclusions- summer has arrived.  Granted, summer officially began on June 21, but given all that’s transpired since last summer, I think we can excuse investors from delaying their summer vacations this time around by a few weeks, until the kickoff of second quarter earnings season.

Summer usually means a couple things for the financial markets: less liquidity/volume and less fluctuations. The decline in volume is largely self-explanatory, due to what can best be summarized as more play and less work. The decline in volatility is due to a different, but related cause, which is a delay in important investment decisions until the fall, when traders return to their desks and resume monitoring the markets full-time. Both phenomena tend to cause asset prices to move sideways.

This is especially true for forex markets. “Traders noted major currency pairs remain largely range-bound…Markets for now are hung up by uncertainty over the shape of any future economic recovery, he said. Economic data at this point ‘can be spun either way,’ likely leaving currency markets next week to key off of any earnings surprises from U.S. companies,” observed one analyst. As far as the decline in volume is concerned, “Emerging markets are becoming particularly volatile as liquidity declines over the summer period,” and “Bid-offer spreads are quite wide.”

Kathy Lien, of Forex 360, has observed another summer trend: “Over the past 10 years, the Canadian, Australian and New Zealand dollars have seen their steepest slides in the month of July. In addition, we have seen the U.S. dollar outperform the Canadian and New Zealand dollars 8 out of the past 10 years during this month.” This could be a byproduct of delayed allocation, as investors shift capital out of risky markets/positions/currencies. The lesson might be to stick to the majors.

Based on all current indications, this summer will be no exception to this rule. While investors have certainly grown more complacent about risk over the last few months, there is a lingering uncertainty. “Economic data at this point ‘can be spun either way,’ likely leaving currency markets next week to key off of any earnings surprises from U.S. companies.” Even with across-the-board positive earnings results, investors will likely remain wary and could hold off on taking any risky (overseas) positions until the fall.

I toyed with today’s headline for a while, given that an equally cogent case could be made for either “Chinese Yuan Poised for Significant Appreciation” or “Chinese Yuan Poised for Stability.” Let’s face it- when it comes to to the Chinese Yuan, it’s a complete guessing game, since you’re not only dealing with the normal factors that affect currencies, but also with the whims of China’s Central Bank. Still, I think that the Yuan will continue to appreciate slowly and steadily, because such is in the best interest of China.

For the sake of context, consider that the Central Bank has held the Yuan around $6.83 for the better part of a year now, since the advent of the credit crisis. Prior to that, it had appreciated nearly 20% over the previous three years. The reason China has been able to get away with holding the Yuan constant for such a long period of time is the collapse in its trade surplus. Meanwhile, inflation has abated, down from a high of 7% to the current level of near 0%. As a result, the Central Bank can now have its cake and eat it to, by holding the Yuan constant without worrying about the effect on prices.

The most recent forecasts, however, suggest this is about to change. According to the World Bank, “China’s current-account surplus is likely to reach $388 billion in 2009…while foreign-exchange reserves will likely rise by $218 billion to $2.168 trillion at the end of this year.” Depending on who you ask, China’s economy is on track to grow by 7.2% to 7.5% in 2009, and by 8.5% in 2010. These forecasts represent upward revisions, and “Private economists have also been upgrading their outlook for China’s economic growth this year in the past couple of months since some major indicators including fixed-asset investment and industrial output growth have shown signs of improvement.” Second-Quarter GDP is scheduled for release in the next week, at which point we will likely see another round of revisions.

If such growth materializes, this would place China in a dilemma, such that it would have to choose between higher prices or more expensive currency. According to the Royal Bank of Scotland, “Policy makers will keep benchmark interest rates on hold this year because of declining consumer prices,” which implies, “The yuan will strengthen to 6.7 by the end of 2009 and 6.5 a year later.” Chinese Premier Wen JiaoBao agrees that “China should stick to an appropriately loose monetary stance and an active fiscal policy.” This notion is also reflected in futures prices, which have priced in a modest 1-2% rise in the Yuan over the next year [compared to previous expectations of a 5% decrease].

Economics aside, there is another major reason why the Yuan should continue to appreciate. China has been clamoring for several months now for a decline in the Dollar’s role as the world’s reserve currency, and a commensurate rise in the Yuan. Already, the country has started to take steps to increase the use of Yuan in settling cross-border trade, and “HSBC predicts that by 2012 nearly $2 trillion of annual trade (over 40% of China’s total) could be settled in yuan, making it one of the top three currencies in global trade.”

Still, the currency is still nowhere near satisfying the requisite convertibility inherent in reserve currencies. According to one analyst, “China would need to scrap capital controls so foreigners could invest in yuan assets and then freely repatriate their capital and income, but the government is wary of moving too quickly. A reserve currency also requires a deep and liquid bond market, free from government interference.” If China is able to achieve any of these feats, capital will likely pour in at an even faster rate, making an appreciation in the Yuan once again self-fulfilling.

I toyed with today’s headline for a while, given that an equally cogent case could be made for either “Chinese Yuan Poised for Significant Appreciation” or “Chinese Yuan Poised for Stability.” Let’s face it- when it comes to to the Chinese Yuan, it’s a complete guessing game, since you’re not only dealing with the normal factors that affect currencies, but also with the whims of China’s Central Bank. Still, I think that the Yuan will continue to appreciate slowly and steadily, because such is in the best interest of China.

For the sake of context, consider that the Central Bank has held the Yuan around $6.83 for the better part of a year now, since the advent of the credit crisis. Prior to that, it had appreciated nearly 20% over the previous three years. The reason China has been able to get away with holding the Yuan constant for such a long period of time is the collapse in its trade surplus. Meanwhile, inflation has abated, down from a high of 7% to the current level of near 0%. As a result, the Central Bank can now have its cake and eat it to, by holding the Yuan constant without worrying about the effect on prices.

The most recent forecasts, however, suggest this is about to change. According to the World Bank, “China’s current-account surplus is likely to reach $388 billion in 2009…while foreign-exchange reserves will likely rise by $218 billion to $2.168 trillion at the end of this year.” Depending on who you ask, China’s economy is on track to grow by 7.2% to 7.5% in 2009, and by 8.5% in 2010. These forecasts represent upward revisions, and “Private economists have also been upgrading their outlook for China’s economic growth this year in the past couple of months since some major indicators including fixed-asset investment and industrial output growth have shown signs of improvement.” Second-Quarter GDP is scheduled for release in the next week, at which point we will likely see another round of revisions.

If such growth materializes, this would place China in a dilemma, such that it would have to choose between higher prices or more expensive currency. According to the Royal Bank of Scotland, “Policy makers will keep benchmark interest rates on hold this year because of declining consumer prices,” which implies, “The yuan will strengthen to 6.7 by the end of 2009 and 6.5 a year later.” Chinese Premier Wen JiaoBao agrees that “China should stick to an appropriately loose monetary stance and an active fiscal policy.” This notion is also reflected in futures prices, which have priced in a modest 1-2% rise in the Yuan over the next year [compared to previous expectations of a 5% decrease].

Economics aside, there is another major reason why the Yuan should continue to appreciate. China has been clamoring for several months now for a decline in the Dollar’s role as the world’s reserve currency, and a commensurate rise in the Yuan. Already, the country has started to take steps to increase the use of Yuan in settling cross-border trade, and “HSBC predicts that by 2012 nearly $2 trillion of annual trade (over 40% of China’s total) could be settled in yuan, making it one of the top three currencies in global trade.”

Still, the currency is still nowhere near satisfying the requisite convertibility inherent in reserve currencies. According to one analyst, “China would need to scrap capital controls so foreigners could invest in yuan assets and then freely repatriate their capital and income, but the government is wary of moving too quickly. A reserve currency also requires a deep and liquid bond market, free from government interference.” If China is able to achieve any of these feats, capital will likely pour in at an even faster rate, making an appreciation in the Yuan once again self-fulfilling.

Since touching a low in March, the emerging market class has risen by 50%, according to one measure. This led to concerns that another bubble was forming, a swift pullback ensued. The bulls, however, point out that valuations remain well below 2007-2008 bubble levels and that according to some measures, fundamentals are actually quite strong.

They have a point. With the exception of a few bailouts in Eastern Europe, emerging markets as a whole have actually weathered the storm quite well. As one analyst points out, “Governance has improved, many countries run current-account surpluses, foreign-currency reserves have grown, the middle classes are expanding and savings rates are high. Countries such as Brazil and Turkey have been able to cut rates during the crisis and still attract money.”

In fact, it wasn’t even until the collapse of Lehman Brothers in September 2008 (when some might say the credit crisis entered the worst stage) that investors even began to pull money from emerging markets. “During the first half of 2008, gross capital inflows to EMEs held up remarkably well, in many cases reaching 60–70% of the record high inflows in 2007…The fact that other investors (banks and bondholders) maintained their positions in EMEs may be attributed to a number of factors…including much larger official foreign exchange reserves and more robust banking systems in many cases.”

Accordingly, it could be argued that the recent rally in emerging markets could represent a “reverse correction”- an acknowledgment that the record decline was simply an overreaction. While stocks still remain well below their record highs, bonds are rapidly approaching pre-crisis levels. The spread between the JP Morgan EMBI+ index and US Treasury securities is now approximately where it was one year ago.

The naysayers, though, like to remind people that emerging markets are inherently risky: “The past decade or so alone has seen the Asian crisis, the Russian default and another round of restructuring in Latin America. Populist politics, poor fiscal management, a reliance on foreign-currency borrowing and fixed exchange rates were a magnet for trouble.”

Sound macroeconomic and fiscal policy notwithstanding, it’s clear that certain structural problems remain extant: “In February 2009 it became clear that the state of these economies was deteriorating faster than expected. Many borrowers faced challenges repaying or rolling over their loans. The loss of investor confidence suddenly exposed long-standing vulnerabilities, such as the widespread practice of foreign currency borrowing by households and by small and medium-sized enterprises.” In addition, emerging markets collectively remain heavily reliant on exports to drive growth, which is problematic given that, “The synchronised fall in exports intensified in the first quarter of 2009 with an average year-on-year decrease of around 25% in a set of larger EMEs. In some commodity-exporting countries, notably Chile and Russia, exports fell by more than 40% in the first quarter of 2009.”

The best way to account for this schism between capital inflows and economic uncertainty is a shift in the way emerging market investors view risk. Previously, it was default risk that predominated. Now, however, it is inflation and currency risk, as well as corporate credit risk, that guides investor thinking.

Since touching a low in March, the emerging market class has risen by 50%, according to one measure. This led to concerns that another bubble was forming, a swift pullback ensued. The bulls, however, point out that valuations remain well below 2007-2008 bubble levels and that according to some measures, fundamentals are actually quite strong.

They have a point. With the exception of a few bailouts in Eastern Europe, emerging markets as a whole have actually weathered the storm quite well. As one analyst points out, “Governance has improved, many countries run current-account surpluses, foreign-currency reserves have grown, the middle classes are expanding and savings rates are high. Countries such as Brazil and Turkey have been able to cut rates during the crisis and still attract money.”

In fact, it wasn’t even until the collapse of Lehman Brothers in September 2008 (when some might say the credit crisis entered the worst stage) that investors even began to pull money from emerging markets. “During the first half of 2008, gross capital inflows to EMEs held up remarkably well, in many cases reaching 60–70% of the record high inflows in 2007…The fact that other investors (banks and bondholders) maintained their positions in EMEs may be attributed to a number of factors…including much larger official foreign exchange reserves and more robust banking systems in many cases.”

Accordingly, it could be argued that the recent rally in emerging markets could represent a “reverse correction”- an acknowledgment that the record decline was simply an overreaction. While stocks still remain well below their record highs, bonds are rapidly approaching pre-crisis levels. The spread between the JP Morgan EMBI+ index and US Treasury securities is now approximately where it was one year ago.

The naysayers, though, like to remind people that emerging markets are inherently risky: “The past decade or so alone has seen the Asian crisis, the Russian default and another round of restructuring in Latin America. Populist politics, poor fiscal management, a reliance on foreign-currency borrowing and fixed exchange rates were a magnet for trouble.”

Sound macroeconomic and fiscal policy notwithstanding, it’s clear that certain structural problems remain extant: “In February 2009 it became clear that the state of these economies was deteriorating faster than expected. Many borrowers faced challenges repaying or rolling over their loans. The loss of investor confidence suddenly exposed long-standing vulnerabilities, such as the widespread practice of foreign currency borrowing by households and by small and medium-sized enterprises.” In addition, emerging markets collectively remain heavily reliant on exports to drive growth, which is problematic given that, “The synchronised fall in exports intensified in the first quarter of 2009 with an average year-on-year decrease of around 25% in a set of larger EMEs. In some commodity-exporting countries, notably Chile and Russia, exports fell by more than 40% in the first quarter of 2009.”

The best way to account for this schism between capital inflows and economic uncertainty is a shift in the way emerging market investors view risk. Previously, it was default risk that predominated. Now, however, it is inflation and currency risk, as well as corporate credit risk, that guides investor thinking.

If an investor only read the story, Pound a Buy Before ‘Steep’ U.K. Recovery, they could be forgiven for assuming that the fundamentals underlying the Pound must be strong enough to just such a bold claim. In fact, virtually all economic indicators are trending downward, and most analysts (with the exception of the source behind the above story) are revising their Pound forecasts proportionately.

While all data is subject to “spin,” all of the big picture indicators paint a consistently negative picture of the UK economy. The Organization for Economic Cooperation and Development said on June 24 that U.K. gross domestic product will shrink 4.3 percent this year, revising its March forecast for a 3.7 percent contraction. Sterling has fallen 1 percent in the past month. Meanwhile, unemployment is still rising (albeit at a slower pace than before), and prices are falling.

The BOE will probably expand its liquidity program by the sanctioned 25 Billion Pounds, and “Speculation has also started to circulate that the Bank of England could announce it will seek approval from the Treasury to boost the size of the program even further.” Meanwhile, the government deficit is surging: “The U.K.’s credit rating is an issue that’s still there and public spending in an election year is causing concern for investors.

A sane analyst, then, could only come to one reasonable conclusion- that the Pound is doomed. In the short-term, the Pound will be punished by a weak economic prognosis, low interest rates, and the inflationary monetary/fiscal policy. Additionally, as the summer rolls in, investors will likely move funds outside of the UK into more stable locales. In the long-term, the Pound is equally dubious: “The pound’s decline in 2008 returned the currency to its real trade-weighted exchange rate of the 1970s, which could be its ‘new fair value’ as the U.K. becomes a net oil importer and is less able to rely on financial services to earn foreign exchange.”

There is even less equivocation among investors, themselves. According to the Commodity Futures Trading Commission, “More hedge funds and large speculators have positioned for a decline in the pound against the dollar rather than a rise — so-called net shorts — every week since August.” While the Pound is currently trading around $1.65, “The median of 39 analysts and strategists’ forecasts compiled by Bloomberg is for the pound to trade at $1.59 by the end of September and $1.62 by the end of the year.”

There is a pattern in the following smattering of forex soundbites: “It feels like we’re already in the summer doldrums;” “[We] are moving into summer trading;” “We are in a summer period.” From three different analysts, three identical conclusions- summer has arrived.  Granted, summer officially began on June 21, but given all that’s transpired since last summer, I think we can excuse investors from delaying their summer vacations this time around by a few weeks, until the kickoff of second quarter earnings season.

Summer usually means a couple things for the financial markets: less liquidity/volume and less fluctuations. The decline in volume is largely self-explanatory, due to what can best be summarized as more play and less work. The decline in volatility is due to a different, but related cause, which is a delay in important investment decisions until the fall, when traders return to their desks and resume monitoring the markets full-time. Both phenomena tend to cause asset prices to move sideways.

This is especially true for forex markets. “Traders noted major currency pairs remain largely range-bound…Markets for now are hung up by uncertainty over the shape of any future economic recovery, he said. Economic data at this point ‘can be spun either way,’ likely leaving currency markets next week to key off of any earnings surprises from U.S. companies,” observed one analyst. As far as the decline in volume is concerned, “Emerging markets are becoming particularly volatile as liquidity declines over the summer period,” and “Bid-offer spreads are quite wide.”

Kathy Lien, of Forex 360, has observed another summer trend: “Over the past 10 years, the Canadian, Australian and New Zealand dollars have seen their steepest slides in the month of July. In addition, we have seen the U.S. dollar outperform the Canadian and New Zealand dollars 8 out of the past 10 years during this month.” This could be a byproduct of delayed allocation, as investors shift capital out of risky markets/positions/currencies. The lesson might be to stick to the majors.

Based on all current indications, this summer will be no exception to this rule. While investors have certainly grown more complacent about risk over the last few months, there is a lingering uncertainty. “Economic data at this point ‘can be spun either way,’ likely leaving currency markets next week to key off of any earnings surprises from U.S. companies.” Even with across-the-board positive earnings results, investors will likely remain wary and could hold off on taking any risky (overseas) positions until the fall.

There is a pattern in the following smattering of forex soundbites: “It feels like we’re already in the summer doldrums;” “[We] are moving into summer trading;” “We are in a summer period.” From three different analysts, three identical conclusions- summer has arrived.  Granted, summer officially began on June 21, but given all that’s transpired since last summer, I think we can excuse investors from delaying their summer vacations this time around by a few weeks, until the kickoff of second quarter earnings season.

Summer usually means a couple things for the financial markets: less liquidity/volume and less fluctuations. The decline in volume is largely self-explanatory, due to what can best be summarized as more play and less work. The decline in volatility is due to a different, but related cause, which is a delay in important investment decisions until the fall, when traders return to their desks and resume monitoring the markets full-time. Both phenomena tend to cause asset prices to move sideways.

This is especially true for forex markets. “Traders noted major currency pairs remain largely range-bound…Markets for now are hung up by uncertainty over the shape of any future economic recovery, he said. Economic data at this point ‘can be spun either way,’ likely leaving currency markets next week to key off of any earnings surprises from U.S. companies,” observed one analyst. As far as the decline in volume is concerned, “Emerging markets are becoming particularly volatile as liquidity declines over the summer period,” and “Bid-offer spreads are quite wide.”

Kathy Lien, of Forex 360, has observed another summer trend: “Over the past 10 years, the Canadian, Australian and New Zealand dollars have seen their steepest slides in the month of July. In addition, we have seen the U.S. dollar outperform the Canadian and New Zealand dollars 8 out of the past 10 years during this month.” This could be a byproduct of delayed allocation, as investors shift capital out of risky markets/positions/currencies. The lesson might be to stick to the majors.

Based on all current indications, this summer will be no exception to this rule. While investors have certainly grown more complacent about risk over the last few months, there is a lingering uncertainty. “Economic data at this point ‘can be spun either way,’ likely leaving currency markets next week to key off of any earnings surprises from U.S. companies.” Even with across-the-board positive earnings results, investors will likely remain wary and could hold off on taking any risky (overseas) positions until the fall.

I toyed with today’s headline for a while, given that an equally cogent case could be made for either “Chinese Yuan Poised for Significant Appreciation” or “Chinese Yuan Poised for Stability.” Let’s face it- when it comes to to the Chinese Yuan, it’s a complete guessing game, since you’re not only dealing with the normal factors that affect currencies, but also with the whims of China’s Central Bank. Still, I think that the Yuan will continue to appreciate slowly and steadily, because such is in the best interest of China.

For the sake of context, consider that the Central Bank has held the Yuan around $6.83 for the better part of a year now, since the advent of the credit crisis. Prior to that, it had appreciated nearly 20% over the previous three years. The reason China has been able to get away with holding the Yuan constant for such a long period of time is the collapse in its trade surplus. Meanwhile, inflation has abated, down from a high of 7% to the current level of near 0%. As a result, the Central Bank can now have its cake and eat it to, by holding the Yuan constant without worrying about the effect on prices.

The most recent forecasts, however, suggest this is about to change. According to the World Bank, “China’s current-account surplus is likely to reach $388 billion in 2009…while foreign-exchange reserves will likely rise by $218 billion to $2.168 trillion at the end of this year.” Depending on who you ask, China’s economy is on track to grow by 7.2% to 7.5% in 2009, and by 8.5% in 2010. These forecasts represent upward revisions, and “Private economists have also been upgrading their outlook for China’s economic growth this year in the past couple of months since some major indicators including fixed-asset investment and industrial output growth have shown signs of improvement.” Second-Quarter GDP is scheduled for release in the next week, at which point we will likely see another round of revisions.

If such growth materializes, this would place China in a dilemma, such that it would have to choose between higher prices or more expensive currency. According to the Royal Bank of Scotland, “Policy makers will keep benchmark interest rates on hold this year because of declining consumer prices,” which implies, “The yuan will strengthen to 6.7 by the end of 2009 and 6.5 a year later.” Chinese Premier Wen JiaoBao agrees that “China should stick to an appropriately loose monetary stance and an active fiscal policy.” This notion is also reflected in futures prices, which have priced in a modest 1-2% rise in the Yuan over the next year [compared to previous expectations of a 5% decrease].

Economics aside, there is another major reason why the Yuan should continue to appreciate. China has been clamoring for several months now for a decline in the Dollar’s role as the world’s reserve currency, and a commensurate rise in the Yuan. Already, the country has started to take steps to increase the use of Yuan in settling cross-border trade, and “HSBC predicts that by 2012 nearly $2 trillion of annual trade (over 40% of China’s total) could be settled in yuan, making it one of the top three currencies in global trade.”

Still, the currency is still nowhere near satisfying the requisite convertibility inherent in reserve currencies. According to one analyst, “China would need to scrap capital controls so foreigners could invest in yuan assets and then freely repatriate their capital and income, but the government is wary of moving too quickly. A reserve currency also requires a deep and liquid bond market, free from government interference.” If China is able to achieve any of these feats, capital will likely pour in at an even faster rate, making an appreciation in the Yuan once again self-fulfilling.

I toyed with today’s headline for a while, given that an equally cogent case could be made for either “Chinese Yuan Poised for Significant Appreciation” or “Chinese Yuan Poised for Stability.” Let’s face it- when it comes to to the Chinese Yuan, it’s a complete guessing game, since you’re not only dealing with the normal factors that affect currencies, but also with the whims of China’s Central Bank. Still, I think that the Yuan will continue to appreciate slowly and steadily, because such is in the best interest of China.

For the sake of context, consider that the Central Bank has held the Yuan around $6.83 for the better part of a year now, since the advent of the credit crisis. Prior to that, it had appreciated nearly 20% over the previous three years. The reason China has been able to get away with holding the Yuan constant for such a long period of time is the collapse in its trade surplus. Meanwhile, inflation has abated, down from a high of 7% to the current level of near 0%. As a result, the Central Bank can now have its cake and eat it to, by holding the Yuan constant without worrying about the effect on prices.

The most recent forecasts, however, suggest this is about to change. According to the World Bank, “China’s current-account surplus is likely to reach $388 billion in 2009…while foreign-exchange reserves will likely rise by $218 billion to $2.168 trillion at the end of this year.” Depending on who you ask, China’s economy is on track to grow by 7.2% to 7.5% in 2009, and by 8.5% in 2010. These forecasts represent upward revisions, and “Private economists have also been upgrading their outlook for China’s economic growth this year in the past couple of months since some major indicators including fixed-asset investment and industrial output growth have shown signs of improvement.” Second-Quarter GDP is scheduled for release in the next week, at which point we will likely see another round of revisions.

If such growth materializes, this would place China in a dilemma, such that it would have to choose between higher prices or more expensive currency. According to the Royal Bank of Scotland, “Policy makers will keep benchmark interest rates on hold this year because of declining consumer prices,” which implies, “The yuan will strengthen to 6.7 by the end of 2009 and 6.5 a year later.” Chinese Premier Wen JiaoBao agrees that “China should stick to an appropriately loose monetary stance and an active fiscal policy.” This notion is also reflected in futures prices, which have priced in a modest 1-2% rise in the Yuan over the next year [compared to previous expectations of a 5% decrease].

Economics aside, there is another major reason why the Yuan should continue to appreciate. China has been clamoring for several months now for a decline in the Dollar’s role as the world’s reserve currency, and a commensurate rise in the Yuan. Already, the country has started to take steps to increase the use of Yuan in settling cross-border trade, and “HSBC predicts that by 2012 nearly $2 trillion of annual trade (over 40% of China’s total) could be settled in yuan, making it one of the top three currencies in global trade.”

Still, the currency is still nowhere near satisfying the requisite convertibility inherent in reserve currencies. According to one analyst, “China would need to scrap capital controls so foreigners could invest in yuan assets and then freely repatriate their capital and income, but the government is wary of moving too quickly. A reserve currency also requires a deep and liquid bond market, free from government interference.” If China is able to achieve any of these feats, capital will likely pour in at an even faster rate, making an appreciation in the Yuan once again self-fulfilling.