In September, the Chinese yuan started rising. In October, Pan Gongsheng, the deputy governor of the People’s Bank of China (PBoC) and administrator of the State Administration of Foreign Exchange (Safe), stated that the renminbi exchange rate would remain stable. Safe’s deputy administrator, Wang Chunying, described China’s foreign exchange transactions as rational and orderly, adding that persistent appreciation or depreciation was unlikely.
In a research note published in mid-November, HSBC’s global head of FX research referred to optimism that China’s regulatory crackdown was taking a breather as one of the reasons why the RMB might stay strong in the near term.
Yet just days later, it was reported that the China Foreign Exchange Committee had told commercial banks they faced investigation if their proprietary trading volumes increased by a certain amount in total or relative to what they executed on behalf of clients.
And with global markets sent into turmoil at the time of writing after Russia invaded Ukraine on Thursday, it remains to be seen how Chinese authorities will respond to fresh volatility.
According to Jacqueline Rong, deputy chief China economist at BNP Paribas, the largely hands-off approach so far is a result of market participants becoming more accustomed to two-way volatility in the yuan, as well as the fact that strong capital inflows and outsized foreign assets held by Chinese entities offer buffers to any reversal in capital flows triggered by either narrowing US-China interest rate differentials or global risk-offs.
Senior EMEA market strategist at BNY Mellon Markets, Geoffrey Yu, notes that the PBoC stated in its in-house publication earlier this year that corporates should be braced for more two-way volatility.
“If one-way expectations bed in, the central bank will be concerned that corporates and banks are not hedging sufficiently,” he says. “Other economic policymakers may argue for the need for one-way weakening in the RMB, but that creates its own issues, so for now we expect greater fluctuations but in a range within the bank’s tolerance.”
Kiyong Seong, lead Asia macro strategist at Societe Generale, agrees that any one-sided herd behaviour could prompt market intervention. He says the main considerations of late have been to maintain low volatility during the Winter Olympics and the national people’s congress, which starts on Saturday.
Fixing the value of the yuan instead of letting it float freely is part of China’s monetary policy strategy. “However, the fixing should not go wildly against market fundamentals and distort pricing, which explains why the yuan has been allowed to appreciate,” says Ipek Ozkardeskaya, senior analyst at Swissquote.
Given the strength of the RMB, it seems the central bank is prepared for a degree of depreciation as the Fed hikes rates, as long as it doesn’t threaten financial stability, adds Xiangrong Yu, chief China economist at Citi.
Strength
The strength seen in the yuan in recent months has been driven by the performance of the China economy, despite a major wobble in the property market that authorities are continuing to grapple with. But there is no guarantee that this situation will continue.
“The economy is likely to see slower growth in the coming years and with the central bank providing additional assistance while those elsewhere are raising rates aggressively, we could see the yuan start to weaken again,” says Craig Erlam, market analyst at Oanda. “The authorities have allowed it to strengthen quite a lot since the onset of the pandemic but it has done so fairly gradually and has not proven to be a major hindrance, which is probably why they have been so tolerant.”
Peter Chia, senior FX strategist at UOB, reckons there is scope for further easing from the PBoC. He expects the one-year loan prime rate to be cut by another 15 basis points (bp) in the first half of this year and a further reduction in the reserve requirement ratio is also expected to help guide lending rates lower.
“We expect a 5bp point cut in the medium-term lending facility rate in April or May,” says Rong. “Although the record high credit numbers shed positive light on potential turnaround in economic growth, we expect Q1 GDP growth to fall short of the desired rate of policymakers, likely in the range 5.0%-5.5%. That means more monetary accommodation will be needed in Q2 to bridge the growth gap.”
Linan Liu, head of greater China macro strategy at Deutsche Bank, anticipates a more aggressive cut in the medium-term lending facility rate as well as a liquidity injection in the next two or three months, while noting that the China-US short-term interest rate differential remains supportive to RMB stability.
Fading trade momentum and a more hawkish Fed will increase depreciation pressure on the RMB, according to Citi’s Yu, who believes USD/CNY will be at 6.4 in three months and 6.5 this time next year.
“Altogether we expect a total of 25bp policy rate reduction and a 50bp reserve requirement ratio cut in the first half of the year,” he concludes.
