As of 4:59 am on June 26th, the offshore Chinese yuan (CNH) was trading at 7.2893 yuan against the US dollar, down 61 points from late Monday trading in New York. The overall intraday trading was in the range of 7.2763-7.2907 yuan. As strong employment data in the United States further slows down the pace of interest rate cuts by the Federal Reserve, the renminbi exchange rate has fallen to a low point for the year.
Affected by changes in international geopolitical risks
The current low exchange rate of the Chinese yuan may be closely related to the latest changes in international geopolitical risks.
Firstly, the significant increase in seats of far right political parties in the European Parliament has raised concerns in the market about the uncertainty of Europe’s future development, leading to a decrease in the risk preference for financial capital investment – starting to withdraw funds from high-risk assets such as emerging markets;
Secondly, Europe pulled the trigger for interest rate cuts before the Federal Reserve, invisibly expanding the advantage of the US dollar interest rate spread, leading many European and American capital to once again be bullish on the US dollar and choose to short emerging market currencies such as the renminbi;
Third, the Palestinian Israeli conflict and the Russia-Ukraine conflict continued to escalate. In addition, the unexpected sharp drop of gold and other safe haven assets during the Loong Boat Festival led more European and American capital to once again favor US debt as a safe haven, which led to the transfer of funds from emerging markets to US debt assets in succession, and also led to a corresponding decline in the RMB exchange rate.
Most overseas investment institutions also believe that this is mainly influenced by short-term fluctuations in market hedging sentiment. In the medium to long term, as the fundamentals of the Chinese economy continue to improve, coupled with the fact that the Federal Reserve will sooner or later trigger interest rate cuts, there is a high probability that the RMB exchange rate will quickly hit bottom and rebound.
Central Bank Governor Pan Gongsheng speaks with a huge signal
At the Lujiazui Forum held on June 19th, Pan Gongsheng, the President of the People’s Bank of China, pointed out that “the RMB exchange rate has maintained basic stability in complex situations. This year, the timing of the monetary policy shift in major developed economies has been continuously adjusted, and the US China interest rate spread (inverted range) has remained relatively high. We adhere to the decisive role of the market in the exchange rate formation mechanism, but at the same time, we will strengthen expectation guidance and resolutely prevent exchange rate overshoot.”
In the view of industry insiders, the current decline in the RMB exchange rate is relatively low. The reason behind this is that compared to other countries that have intervened in the foreign exchange market by consuming foreign exchange reserves, Chinese relevant departments have more sufficient tools to stabilize the exchange rate, which makes speculative capital quite wary and hesitant to stir up trouble.
How will the RMB go in the future?
Zhu Hexin, Vice President of the People’s Bank of China and Director of the State Administration of Foreign Exchange, recently pointed out that in the future, China’s foreign exchange market has the foundation and conditions to maintain stable operation, and the RMB exchange rate will remain basically stable at a reasonable and balanced level.
In his view, the main supporting factors can be summarized as “three more”: firstly, the economic fundamentals are more solid; Secondly, the market resilience is more pronounced; The third is to have richer experience in dealing with it.
Zhu Hexin mentioned that China’s foreign exchange market participants are more mature, exchange rate hedging tools are more widely used, the proportion of cross-border use of the RMB is steadily increasing, and foreign exchange market transactions remain rational and orderly. Meanwhile, in recent years, China’s foreign exchange market has successfully responded to multiple rounds of high-intensity external shocks and accumulated rich experience. “In the future, we will continue to pay close attention to changes in the external environment, further utilize the policy toolbox, and prevent the risk of RMB exchange rate overshoot and abnormal cross-border fund flows.”
Pang Ming, Chief Economist of JLL Greater China, believes that from the perspective of economic fundamentals, the Chinese economy continues to operate in an upward trend, and the positive factors for medium – and long-term development are further strengthened. The renminbi and Chinese assets will continue to provide sustained, stable, safe, and long-term investment opportunities.
Pang Ming predicts that the decisive role of the market in the RMB exchange rate will be upheld, the elasticity of the RMB exchange rate will be enhanced, the risk of exchange rate overshoot will be effectively prevented, the strength and mechanism of exchange rate correction will be sound, the RMB exchange rate will steadily rebound, moderately strengthen, and continue to maintain basic stability at a reasonable equilibrium level.
Increasing the flexibility of the RMB exchange rate may be the key to breaking the deadlock
Since June this year, except for a slight decline in the 3-month interest rate spread between China and the United States, both the 1-year and 10-year interest rate spreads have widened again. A noteworthy detail is that behind this widening interest rate spread, there is also a lower annualized volatility of the onshore renminbi. In this way, the valuation risk exposure of carrying trades between the US dollar and the Chinese yuan is greatly reduced, invisibly promoting carry trades under high interest spreads.
So, in the case of stable fundamentals, the key to stabilizing the RMB exchange rate seems undisputed, which is to increase the volatility of the RMB exchange rate from a trading perspective.
The main basis is that China’s current asset account adopts a pipeline based opening strategy. Although there are some different views, it seems that it is precisely because of the regulatory measures of the capital account that China is able to maintain the independence of its monetary policy.
Currently, carry trading is mainly achieved through current account transactions. For example, foreign trade enterprises with qualifications for foreign exchange settlement and sales, facing the continuous widening interest rate gap between China and the United States, generally choose to retain more US dollars and reduce the proportion of foreign exchange settlement for export earnings. Simply put, it means retaining the spread and exchange gains brought by high interest rates in the US dollar. Another common operation is to use swap tools to sell foreign exchange.
These two spontaneous behaviors based on rational economic agents can easily form a “synthetic error” in the spot foreign exchange market, resulting in insufficient foreign currency supply in the spot foreign exchange market and further putting pressure on the local currency exchange rate.
From the perspective of the transaction itself, a combination of “high spread” and “low volatility” can easily trigger arbitrage behavior. Because in terms of carry trading itself, the smaller the exchange rate fluctuation, the more stable the valuation (P/L) of the carry position. The current stable or relatively low fluctuation level of the RMB exchange rate trend makes this operation a highly valued moat.
Overall, under the constraints of the short-term divergence of interest rates between China and the United States, starting from a trading perspective, it may be a good choice to appropriately increase the volatility level of the RMB and reduce the cost-effectiveness of the previous carry trading between the RMB and the US dollar.
Post time: Jun-28-2024