On September 18, after the Federal Open Market Committee (FOMC) meeting, the monetary policy decision will be announced. The consensus expects that rate cuts will begin. According to experts, there are possible effects of this measure that have not yet been properly addressed, including the repatriation of Chinese capital. The latter could generate a chain of effects with possible implications for Bitcoin.
In this article, we analyze some of the key points of the possible strengthening of the Chinese yuan as a result of the rate cut. We also analyze the impact of this on the Cryptocurrency market.
The rate cut and its possible implications for Bitcoin
The theory suggests that a rate cut translates into greater ease for companies when it comes to repaying their loans. Thus, the capital saved on rates is directed towards stimulating economic growth and, as a consequence, towards improving stock market assets.
The correlation between the S&P 500 and the crypto market is strong. Hence, the reduction in the price of money will favor the rise of BTC. Thus, a new period of economic growth, outstanding corporate profits and high returns on financial assets would be at the door.
The latter – more or less – is what can generally be read in the analyses of the crypto market. However, there is another side, the one least addressed by experts and which could explain the fact that cryptocurrencies are in the red despite the fact that the soft landing is close to being consummated.
Such a scenario has to do with the sharp depreciation of the US dollar in the face of lower rates. Specifically, the greenback would take a beating against the Chinese yuan. The Asian country’s capital, represented in yielding assets in the US currency, would experience a massive outflow. The possible implications of this on Bitcoin are twofold and depend on the magnitude of the dollar’s fall.
Repatriation of Chinese capital will strengthen the yuan
In a recent report published by Bloomberg, expert Stephen Jen of Eurizon SLJ Capital addresses the issue of capital repatriation to China. Companies in the Asian country with assets denominated in USD would act in response to the lowering of the price of the US currency. Thus, approximately $1 trillion dollars would be directed to that nation from the US.
Such a surge, which Jen describes as an avalanche, would strengthen the yuan by 5% to 10% against the dollar. Since the pandemic, Chinese companies have accumulated up to $2 trillion in foreign assets, mostly in higher-yielding dollar assets. The interest rate cut translates into a decrease in the attractiveness of these and, therefore, a signal of liquidation.
The expert concludes that the figure could be conservative and top $1 trillion as interest rates between China and the US become more balanced. In simple terms, this whole scenario translates into a huge weakening of the dollar.
In theory, a weak dollar offers benefits to financial markets. However, this can change depending on the magnitude of the weakness and how long it lasts.
On the positive side, a weak dollar offers greater export competitiveness or debt reduction. On the negative side, however, it could generate extreme financial volatility, increased inflation and a strong dependence on exports.
Since the pandemic, Chinese companies have accumulated up to $2 trillion in dollar-denominated assets. Source: Bloomberg
A scenario similar to the collapse of the carry trade with the yen
If China’s central bank does not intervene quickly, the yuan’s appreciation could have major implications. Some experts warn that a situation similar to the carry trade with the Japanese yen could occur. In this sense, widespread panic could take hold in Asian markets.
This is the view of Guan Tao, an expert at Bank of China International. On the other hand, it should not be overlooked that the central bank is also cautious about allowing the yuan to appreciate excessively. A too strong appreciation of the currency could harm the competitiveness of exports and hinder China’s economic recovery.
In any case, for Jen, an appreciation of between 5% and 10% would be acceptable enough for the People’s Bank of China. The result would be the aforementioned avalanche of capital repatriation. He also points out that the first rate cut would not be a strong repatriation trend, but only when the low price of money becomes more evident.
As already mentioned, this could have negative effects on Bitcoin, such as high volatility. This is probably the reason why the expected interest rate cuts do not generate much enthusiasm among cryptocurrency investors.
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