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Xi has chance to clarify China role on world stage

What can Yellen and Xi do for markets

The presidents of the U.S. and China will discuss thorny issues such as cyber espionage, the South China Sea, and North Korea's nuclear threat, but one unspoken agenda item this week may be China's efforts to become recognized as more of an equal to the U.S. on the global financial stage.

Markets have their own wish list for the visit by Chinese President Xi Jinping and that is to hear reassurances on the Chinese economy after weeks of volatility in the Chinese stock market and also some clarity on China's somewhat confusing currency policy.

"I do think Xi is going to say the markets have exaggerated how bad China is. They are going through a transition, they made some important progress and China is not going to go through a recession," said Marc Chandler, chief currency strategist at Brown Brothers Harriman.

President Barack Obama walks with Chinese President Xi Jinping at a welcome ceremony in the Great Hall of the People in Beijing on Nov. 12, 2014.
Greg Baker | AFP | Getty Images

Xi arrives in Seattle Tuesday and gives a speech Tuesday evening. He will meet business leaders such as Warren Buffett, Bill Gates and Apple's CEO before heading to Washington on Thursday where he will speak with President Barack Obama. He is also scheduled to speak at the United Nations.

The meeting between Xi and Obama comes just weeks before the November review on whether to include the yuan in the IMF's Special Drawing Rights basket, which would give it reserve currency status. The yuan was rejected in the last review process five years ago, and, while largely symbolic, inclusion could increase central bank demand for the yuan and elevate China's influence in the global economy.

China's recent devaluation of its currency sent ripples through global markets as traders worried China would continue to weaken the yuan. China was also dealt a setback in June when its mainland stock markets were denied inclusion in the MSCI emerging markets index, which would have increased foreign participation in its markets.

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After the Fed held off hiking interest rates last week, markets became even more spooked about China's economy and its central government's ability to make the right policy moves to bolster confidence. The Fed highlighted concerns that international developments could hurt the U.S. economy when it announced its rate decision.

"They're desperately looking for legitimacy in international markets. They missed being included in MSCI's emerging market basket because of a lack of policy clarity and opacity in the way markets are governed and the influence the central government has on markets," said Wells Fargo global market strategist Peter Donisanu. "Because of that foreign capital was not able to make its way into the local markets."

Premier Li Keqiang was quoted Monday as telling the visiting British finance minister that there is no basis for continued depreciation of the currency and that China will continue to "nurture capital markets that are open, transparent and stable in the long term." Xi is expected to bring the same message to the U.S.

"The last hurdle it had was allowing its currency to be more market based. That's where you saw the devaluation a couple weeks ago. That really was a change in policy, a change in the way the currency was calculated," said Donisanu.

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The U.S. has the biggest vote on the IMF, and Treasury Secretary Jacob Lew told China after it devalued its currency that it needs to communicate its policy more clearly.

For the markets, "At this point in time, I think the real salient points of the meeting are going to be around trade," said Donisanu. "The central government wants China to ascend not only to a market-based economy but also ascend to the IMF reserve currency status."

Clem Miller, portfolio manager with Wilmington Trust Investment Advisors, said the IMF standing is political and not significant economically because there would be no requirement that the yuan be used by other central banks. "Much more significant on the ground is the fact that the Chinese government is setting up all these currency swap lines with various countries, and that's much more significant because they can swap currencies and do it at the government-to-government level," he said.

"I know the staff at the IMF is wary because they know the authorities intervene in their currency frequently…. They look at what's going on in the stock market there and they see market intervention there. When you look at the broader picture, it's not like the broader Chinese economy is a market economy. It's a quasi-market economy," Miller said.

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Donisanu said China is seeking to speed up recognition as a top economy and currency. "Time is running out from them. Up until recently, the growth story in China has been manufacturing and the transition from a manufacturing economy is taking place but in order for that pivot to services to continue, the local governments need additional sources of financing to reduce their own debt burden," he said. "One of the most favorable options at this point to obtain that financing is through the open markets. Open markets would call for foreign investor capital, making this move toward international legitimacy important. By being part of the currency reserve basket could entice institutional investors to participate in the Chinese bond markets."

Donisanu said Xi is not likely to try to clarify any policies, but may suggest there was a misinterpretation of comments on the repegging of the currency.

"He's very tight lipped, very orchestrated, so the things he says are very deliberate," said Donisanu. He said the market expects to hear a canned speech from Xi. "Any discussion around the ascension of China from an emerging market to a development to a global leader ... if we hear any language around that context, I think that could be a boost to markets."

JPMorgan international economist David Hensley said he does not expect to get much new insight from Xi. "Obviously, everybody's keen to understand better what's happening with growth and policy in China, and I'm sure this is going to come up both in the business meetings and with the president, and if he (Xi) does have a press conference," said Hensley. "I think they've tried to deal with this issue already in other forums, including the G-20 meeting, to try to reassure that they're not doing anything radical with regards to their currency, which is a sore point, not only here but in Asia."

China has been looking to reform policy but it has been criticized for using a heavy hand in markets it is trying to open up, and traders have been skeptical that the country's economic reports are not trustworthy.

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"One of his important messages is going to be just to reassure people that the Chinese economy is slower but not weak and is not a source of instability, and that policymakers have a steady hand and know what they're doing. Are we going to learn anything from that? Probably not. It's more about tone. Does he establish the confidence that's been missing up to now?" said Hensley.

While the U.S. would see very little direct impact from a weaker China, the worry has been that China's slowing will filter through to the U.S. economy via emerging markets as well as bringing deflation from falling commodities prices. JPMorgan economists in a report said a 1 percent GDP shock in China equates to a half-point drag on global growth. The hit on emerging markets is one for one, but the drag on development markets is more like 0.2 percent, according to JPMorgan.