Profit When China Removes Currency Cap

The Forex world was shocked when the Swiss Central Bank removed the currency cap on the Swiss franc versus the Euro. According their central bank the Swiss were forced by circumstances to remove the currency cap. Newsweek reports the news.

The Swiss franc has risen dramatically against the euro following the unexpected removal of the long-standing exchange-rate control by the Swiss National Bank (SNB). The cap – which was introduced in 2011 – was designed to prevent the Swiss currency from falling below 1.20 francs per euro in order to protect Swiss exporters.

The announcement on Thursday immediately sent the currency market into a flurry of panic, causing the Swiss franc to soar by around 37% in value against the euro at its peak. Whilst it has since leveled out, it still remains at around 30% of pre-removal value.

It simply was going to be too expensive to continue to buy Euros as the EU institutes quantitative easing to stimulate their economy and fight inflation. Those who were betting on a weaker franc at 20 fold leverage were wiped out. Those who were in the opposite trade made huge profits. The question we pose today is who will profit when China removes its currency cap!

Is China Next?

The practice of buying foreign currency to suppress the value of your own is a common monetary policy for countries like Japan, Taiwan and China. However, it becomes expensive over time. MarketWatch wonders out loud if China will be the next Forex peg to break.

The surprise move by Switzerland to scrap its currency ceiling against the euro EURCHF, -0.97%  last week is a reminder there can be unexpected collateral damage from central banks waging currency wars. As markets digest last week’s turmoil, expect focus to turn to other fault lines on the global currency map.

Here China stands out, as like the Swiss, it runs an implicit currency peg that is becoming increasingly painful to maintain.

Due to its longstanding crawling peg to the U.S. dollar, the yuan USDCNY, -0.15% USDCNH, +0.00%  has increasingly found itself pulled higher against just about every major currency. The world’s largest exporter has already had to endure two years of aggressive yen USDJPY, +0.70% devaluation since the introduction of Abenomics and its accompanying quantitative easing.

To the extent that China has had a thriving economy with double digit economic growth the policy of suppressing its currency is effective. Now that the Chinese economic miracle is slowing down and deflation is knocking at the door it may simply become to expensive to keep buying and losing in Forex trading. But, how can you profit when China removes the currency cap?

Will Yuan Currency Cap Removal Be Another Swiss Surprise?

What China would like eventually is for the yuan to be an international currency. They would like to export and be paid in yuan and they would like to use their currency directly for foreign investments and purchases. According to Reuters China is a fourth of the way there. A quarter of China’s payments are now in yuan.

Nearly a quarter of all cross-border payments in China last year were settled in yuan, the central bank said on Tuesday, underscoring the renminbi’s growing dominance as it heads into the league of major currencies.

A total of 9.95 trillion yuan ($1.6 trillion) worth of cross-border payments were made in yuan last year, the People’s Bank of China (PBOC) said in a statement on its website, as it vowed to increase international usage of the currency this year.

For this policy to be totally successful China needs to remove its currency cap and let the yuan float normally with other major currencies. But, when will this happen and how? In all likelihood the decision, like that of the Swiss will come as a surprise or a series of small surprises. Those who trade in markets where the yuan trades will be positioned to profit when China removes its currency cap.