As China’s central bank announced a comprehensive downgrade, the yuan against the U.S. dollar exchange rate quietly continued to strengthen. on the morning of Dec. 8, the onshore and offshore yuan rushed higher hand in hand, both breaking through the highs in May this year and hitting new highs since May 2018.
As of 16:30 daytime close on December 8, the onshore RMB closed at 6.3535 against the USD, up 143 points from the previous day. Although the yuan exchange rate recently unhindered by the strengthening of the U.S. dollar index, staged a wave of firm appreciation of the independent market, but the risk of renminbi exchange rate retracement depreciation is also increasingly worthy of vigilance, especially in the next year, China and the United States monetary policy or tend to diverge window period, the analysts interviewed believe that the yuan exchange rate is easy to depreciate difficult to rise, the exchange rate inflection point is forming.
The short-term strong pattern of the yuan is difficult to shake
The deviation between the RMB/USD exchange rate and the US dollar index has gradually drawn market attention since November, and triggered policy risk tips. This was interpreted by the market as implying that the appreciation of the RMB had deviated from the pivot.
The CFETS RMB exchange rate index rose by 0.82% from November 19 to December 3, while the US dollar index rose by only 0.1% during the same period.
The factors supporting the independent strength of the RMB exchange rate are multiple. Wang Youxin, a senior researcher at the Bank of China Research Institute, said in an interview with the Securities Times that since November, the U.S. dollar index has moved rapidly higher in anticipation of the Federal Reserve’s tightening monetary policy, but the trend of the yuan has remained stable or even appreciated slightly during the same period, mainly due to the following factors: First, in the context of deepening bottlenecks in the industrial chain of overseas supply chains, China’s export orders have continued to increase, and the trade surplus and foreign exchange revenue remained high, which strongly supported the RMB exchange rate. Second, since last year, the RMB’s investment and hedging attributes have been continuously highlighted. With the increased openness of China’s financial market, foreign investors continue to increase their holdings of RMB bonds and equity assets, especially with the emergence of new mutant strains overseas, making the market hedge and the RMB more favored. Third, overseas inflation is high while China’s inflation stays at a low level, which also boosts the RMB to a certain extent from the perspective of purchasing power parity.
Zhang Yu, a chief macro analyst of Huachuang Securities, also told the reporter that there are two factors worthy of attention to push the RMB exchange rate against the trend. First, the recent spot trading volume of RMB against USD is significantly enlarged, and the trading sentiment is pushing the exchange rate stronger. The second is that due to the widening trade surplus and the simultaneous high surplus of foreign-related receipts and payments by banks on behalf of their clients, enterprises’ willingness to settle foreign exchange has led to stronger demand for settlement by banks on behalf of their clients.
Exchange rate inflection point is forming, next year may be slightly weaker
While the RMB exchange rate is strengthening, the motivation to push the exchange rate depreciation back is also building up. In Zhang Yu’s view, a major inflection point in the RMB exchange rate is forming.
“The continued strength of the RMB exchange rate after the pandemic may be drawing to a close, and the RMB exchange rate will be easy to depreciate but difficult to rise next year.” Zhang Yu said.
A few days ago, China’s national foreign exchange market self-regulatory mechanism work conference appeared a new reference to “the degree of deviation is proportional to the corrective force”, which seems to imply that the appreciation of the yuan has deviated from the pivot. Regardless of whether the exchange rate is appreciating or depreciating, once the exchange rate deviates excessively from the fundamentals due to trading factors or expected factors, it will face the market’s spontaneous corrective force or policy corrective force afterwards, and the farther the deviation, the greater the subsequent corrective force.
According to Zhang Yu’s explanation, the current RMB exchange rate needs to focus on the risk of depreciation in three aspects: First, the new $50,000 domestic resident facilitated exchange quota refresh generation early next year, which will cause some seasonal depreciation pressure on the RMB exchange rate from the historical pattern. Secondly, the Fed’s attitude is gradually turning “hawkish” and the monetary policy tightening cycle will begin, with federal funds futures already pricing in the first rate hike in July 2022; at the same time, the difference in economic growth between China and the U.S. is narrowing, and the difference in real GDP growth between China and the U.S. next year may narrow to the smallest since 1989. During the three historical rounds of economic and currency divergence between the U.S. and China, the RMB has tended to depreciate. Third, the support of capital inflows to the RMB exchange rate in 2022 is also weakening. As the Fed enters a tightening cycle, emerging market economies such as China run the risk of capital outflows and falling asset prices.
Wang Youxin reminded that domestic monetary policy making will face more challenges in the context of the Fed’s tightening monetary policy. Monetary policy should not only focus on economic recovery, but also consider the issue of financial stability, in order to reduce the spillover impact of monetary policy adjustments in developed economies on China, domestic monetary policy there is forced to adjust the pressure.
However, although many analysts believe that the RMB exchange rate will be easy to depreciate next year and difficult to rise, its retracement is expected to be relatively manageable. “The current difference between China and the United States 10-year Treasury yields of more than 140BP, China and the United States spread is ‘thick enough’, the current RMB against the dollar exchange rate is also about 7.1 low than the previous period to leave enough strategic depth. From these two aspects, even if the Federal Reserve tightens monetary policy, it will not be too much of a constraint on China’s monetary policy independence, exchange rates and cross-border capital flows.” Zhang Yu said.
Wang Youxin also believes that in the last two years, China and the United States monetary policy is not synchronized. China takes more into account the needs of domestic economic development and financial stability when formulating monetary policy, especially as the RMB exchange rate remains relatively strong, making the external constraints on monetary policy weaker and allowing the focus to be on internal equilibrium. The spillover impact of the Fed’s tightening monetary policy on China’s RMB exchange rate and cross-border capital flows will be lower than in the last tightening cycle.
CICC research report expects that along with a further slowdown in export growth, marginal easing of domestic monetary policy and cyclical strengthening of the US dollar, the RMB exchange rate is expected to come under pressure after the Spring Festival and into the second quarter. However, the RMB risk premium will still be oscillating at a low level, overlapping with foreign investment’s allocation demand for treasury bonds, the RMB exchange rate may weaken slightly, and will probably oscillate narrowly around 6.6 along with the economic stabilization and recovery in the second half of the year.
In addition, what is China’s response to the Federal Reserve’s tightening monetary policy in terms of cross-border capital flows? Wang Youxin believes that no additional management tools are needed against the background of stable fluctuations in the RMB exchange rate and cross-border capital flows. However, it is necessary to maintain attention to abnormal fluctuations and short-term market overshoots, and dynamically adjust and update macro-prudential policy tools for cross-border capital flows based on circumstances to ensure stable market fluctuations. Source