08:16 AM EDT, 03/25/2024 (MT Newswires) -- The acceleration of USD/CNY above 7.22 coincided with lower United States yields and this "understandably" raised questions about whether China's central bank (PBoC) has suddenly become more tolerant of a weak currency in pursuit of stronger growth and inflation, said Societe Generale.

Like the Bank of Japan (BoJ), the PBoC opposes abrupt changes and volatility for the simple reason that it undermines confidence and stability, something China can do without as investors fret over the economic outlook and wonder if the country's equities are investable, stated SocGen. The push back by both the BoJ and PBoC overnight Sunday demonstrates the frustration and desire to counter the abrupt moves (and counter-intuitive) of last week in the yen (JPY)and the yuan (CNY).

Both currencies lost ground even as US bond yields retreated after the FOMC, sowing confusion over where bonds and foreign exchange (FX) markets more generally are headed in Q2, wrote the bank in a note to clients. The stronger yuan fixing suggests the PBoC won't allow one-way depreciation, but it can't be ruled that a gradual decline over time towards 7.30 will follow.

SocGen pointed out that a higher CNY fixing above the 7.10 level again on Monday could have resulted in a much higher USD/CNH. For G10, a softer yuan is a tactical blow for those backing stronger AUD/USD and EUR/USD.

Looking back at last week, most banking strategists would have anticipated the new Federal Reserve forecasts on inflation and growth to have rubbed off positively for US yields. It didn't turn out that way. The question now is whether the US curve will bull or bear steepen. Cutting rates multiple times steepens the curve via the front end and is a headwind for the US dollar (USD). Tolerating higher inflation steepens the curve versus the long end and supports the US dollar (fewer cuts), noted SocGen.

The Federal Reserve doubled down on three and the US dollar stumbled before the fireworks in the yuan on Friday. The DXY closed at a 4.5-month high on Friday with a 10-year real yield back below 1.90%. US PCE inflation is the next signpost on Friday. Month- and quarter-end portfolio rebalancing flows will also have a say.

A quiet start to the week in the eurozone will warm up on Wednesday when March consumer price index (CPI) data is published for Spain. France and Italy follow on Friday. The European Central Bank's (ECB) Governing Council member Edward Scicluna sided with Mario Centeno and said a rate cut in April cannot be ruled out but the conclusion after last week's Watchers conference is that June remains the most likely meeting for the first cut.

The outcomes of French (services) and Italian CPI will be judged in this context. ECB and Bundesbank Member Joachim Nagel echoed President Christine Lagarde, saying an initial cut doesn't imply subsequent moves and the ECB plans to operate meeting by meeting as new data comes in. Bund yields like US Treasuries (UST) backed off key resistance levels near 2.50% last week, moving out of the danger zone. The bank wouldn't rule out a return to 2.23% (swaps 2.53%) this week, the early March low.

The consolidation of oil prices at $86/barrel has helped to thwart upside pressure. For EUR/CHF, technicals were overbought following the acceleration through 0.97 and profit taking followed the retracement in EUR/USD. A rally up to 0.98 is now on hold until the dust settles on the yuan but buyers on dips have started to emerge again early Monday. Sweden's Riksbank is forecast to keep rates on hold this week and will most likely reiterate its view that a rate cut is possible in H1.

China portfolio flows from equities were negative for a second week running last week (-$0.9 billion), according to EPFR data. This corroborates the consolidation in the CSI-300 and suggests buyers have again moved to the sidelines in an expression of skepticism about the direction of the economy and the profit cycle. The monthly IIF tracker data in early April will give SocGen a second opinion on whether flows have stalled.

The blip in Asia FX wasn't limited to the yuan last week. India's INR closed at a record low of 83.4250/USD on Friday, ignoring inflows into Indian equities and the ballooning of FX reserves to a record $642 billion, added SocGen. The speed of the drop in the currency raises the pertinent question of whether the Reserve Bank of India (RBI) has loosened its grip (backing off intervention) or whether the move is exaggerated by the spill-over from the yuan. South Korea's KRW and Thailan's THB weren't spared either, losing around 1%.

In Central and Eastern Europe (CEE), SocGen expected Hungary's central bank (MNB) to ease the pace of rate cuts this week to 75bps to slow the pace of depreciation of the forint (HUF). In South Africa, the central bank (SARB) is anticipated to leave rates unchanged at 8.25%. Back in Poland, lawmakers are set to submit a motion to launch a probe against Governor Glapinski for alleged irregularities in the central bank's (NBP) bond-buying and an abrupt interest-rate cut ahead of the last parliamentary election.