China Coughs

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The macro point

As almost every summer, there are many concerns about China. This time, it is its banking sector that is the main focus. But little immediate effect on the yuan. Attention, the Bank of England could ease its monetary policy this week. As every year, we take a summer break. See you on September 2! Happy holidays. It's almost the same every summer. The situation in China causes investors around the world to break out in a cold sweat. This time, it is the banking sector that is the main focus. In the space of a week, 40 banks have disappeared. The country is facing a silent banking crisis which, for now, is not a problem for the global economy. In total, according to unofficial figures, 3,800 small local banks - mainly located in rural areas - are struggling. This represents about 55 trillion yuan in assets, equivalent to 13% of the Chinese banking system. The most troubled banks have up to 40% non-performing loans on their balance sheets, primarily reflecting significant exposure to the crisis-hit real estate sector and large-scale fraud (particularly involving the public sector). For the moment, China has opted for two solutions to tackle the problem: 1) let the smallest banks go bankrupt whose disappearance does not cause serious economic and financial problems; 2) encourage bank mergers. Thus, for example, in the Liaoning province alone, 36 banks have merged into one. But this last option does not completely solve the problems because the bad loans are still there. To prevent the situation from worsening, China must accelerate financial stability legislation. It is significantly behind concerning small banks. However, it must be acknowledged that the five main systemic banks are well-protected and perfectly capitalized. Furthermore, Beijing will certainly be forced to further recapitalize the banks resulting from mergers via special bonds, implying a dynamic bond market. We are not among those who consider that there is, today, a risk of contagion to the global economy. As long as the five systemic banks are safe - which has been the case since 2015 - there should be no problems. However, it is an undeniable concern for the local economy, particularly for SMEs located in provinces highly dependent on bank credit. China recently decided to cut its benchmark interest rate by 10 basis points to stimulate the economy a bit. We consider this to be very insufficient. It is likely that Chinese growth will remain sluggish this year and next, and the structural problems related to real estate and the banking sector will be significant obstacles to activity. Without a healthy banking system, it is known that a massive credit stimulus policy is doomed to fail. It is certainly for this reason that the Chinese government does not consider a major economic support plan and opts instead for very targeted measures. For Europe, and particularly for Germany, China's lack of dynamism is obviously bad news. Stronger growth in Europe will not immediately come from more sustained foreign trade. In Japan, the central bank is beginning to worry about weak consumption. Despite historic wage increases negotiated in the spring, consumption is weakening. Some economists consider it to be only a time lag. Others are more pessimistic. Within the Bank of Japan (BoJ), several members believe that the window of opportunity to raise the benchmark interest rate again is closing rapidly. That is why they advocate for a rate increase as early as July 31. We think this is a likely scenario. A 10 basis point increase in the key interest rate could help the yen a little, which remains very weak. However, we seriously doubt that this will reverse the underlying bearish trend, particularly against the US dollar. In our view, only the start of a rate cut cycle by the American Federal Reserve (Fed) next September could really have a lasting positive effect on the yen.

Technical point

It is often estimated that the summer is conducive to strong fluctuations in currencies, mainly because trading volumes are lower. We expect rather a stabilization of the main currencies close to current levels. This is our central scenario. There is no major risk on the horizon during the month of August. On the Asian side, it is noted that Fed rate cut expectations have the most influence on exchange rates - much more than the decisions of the central banks in the region. This makes sense. Concerning the EUR/USD pair, we expect it to move within its wide range of recent weeks, between 1.06 and 1.10 during the month of August - with a pivot area around 1.08. The supports and resistances displayed below respectively indicate the low and high points within which the rates should evolve during the week.

	Weekly Supports		Weekly Resistances
	S2	S1	R1	R2
EUR/USD	1.0633	1.0721	1.0919	1.0988
EUR/GBP	0.8301	0.8333	0.8511	0.8566
EUR/CHF	0.9511	0.9533	0.9833	0.9933
EUR/CAD	1.4698	1.4872	1.5030	1.5303
EUR/JPY	163.88	165.11	171.99	172.56

Announcements to follow

Before our usual August break, there are two central banks to monitor. On July 31st, we estimate a high probability that the BoJ will raise its rates. On August 1st, the Bank of England (BoE) should follow, lowering rates by 25 basis points. The evolution on the inflation and growth front in the UK is rather positive. It's a good time to act. Above all, we doubt that the BoE can remain apart from the expected Fed rate cuts for long. This is partly already priced in by the market, which means that the impact on the pound sterling should be contained. As mentioned above, we think that this August will be relatively calm for currencies. You can go on vacation with peace of mind. See you on September 2nd. Below you will find publications and events that should have a major impact on the evolution of currency rates.

Day	Time	Country	Indicator	What to expect?
On 31/07/2024	05:00	JAP	Central bank meeting	Possible new rate hike.
On 31/07/2024	20:00	USA	Central bank meeting	Nothing
On 01/08/2024	13:00	UK	Central bank meeting	Start of the rate cut cycle
On 02/08/2024	14:30	USA	July employment and unemployment figures	June unemployment rate at 4.1%.