Chinese Central Bankers Jawbone Market, Now What?

SCMP: China’s central bank governor Yi Gang talks up the yuan, helps Shanghai stocks end in positive territory
iFeng: 易纲、潘功胜同日喊话外汇市场,人民币贬值何解?
On July 3, Yi Gang, academic advisor of the China Financial Forty Forum (CF40) and president of the People's Bank of China, accepted an interview with the China Securities Journal and explained the current fluctuations in the foreign exchange market. “We are paying close attention to this, mainly due to the US dollar. Strong and external uncertainties and other factors, some procyclical behavior."

He said that China's current economic fundamentals are good, financial risks are generally controllable, transformation and upgrading are accelerating, the economy enters a stage of high-quality development, the international balance of payments is stable, and cross-border capital flows are generally balanced. China implements a managed floating exchange rate system based on market supply and demand, with reference to a basket of currencies. Practice over the years has proven that this system must be effective and must be adhered to.

Yi Gang said, "We will continue to implement a prudent and neutral monetary policy, deepen the reform of exchange rate marketization, use existing experience and sufficient policy tools, and play a good role in regulating macroeconomic prudential policies to maintain a reasonable and balanced RMB exchange rate. Basically stable."
What follows are snips from a article by Guan Tao.
The current focus of the RMB exchange rate policy is market-oriented reform

The exchange rate system is relatively stable, and the exchange rate policy is relatively flexible. Under the system of managed floating exchange rate, the RMB exchange rate policy keeps pace with the times as the situation develops and changes.

After the “8·11” exchange rate reform in 2015, faced with the pressure of capital outflow and exchange rate depreciation, China adopted a different approach from the past, that is, the RMB exchange rate was adjusted with reference to the basket currency, and continued to have a management float. Because the US dollar continued to rise in the international market, driving the domestic RMB exchange rate lower, by the end of 2016, the central parity of the RMB exchange rate fell 12% compared with the “8·11” exchange rate on the eve (Figure 1), and the market panic spread. At this time, the key point of the RMB exchange rate policy is undoubtedly to let the government's goal of keeping the RMB exchange rate basically stable at a balanced and reasonable level to win the trust of the people and avoid the vicious circle of depreciation of self-reinforcement and self-realization.

In 2017, under the background of fundamental improvement and capital flow management, by introducing “counter-cyclic factor” and optimizing the mid-price quotation mechanism, the RMB exchange rate against the US dollar has appreciated by more than 6% (Figure 1), and the managed floating exchange rate option has been solved in one fell swoop. Market transparency and policy credibility issues. After the issue of credibility was resolved, not only did the RMB exchange rate stabilize, but the foreign exchange reserves were also saved. Because the exchange rate and the reserve are not guaranteed, the level of protection and the size of the insurance are guaranteed.

The 19th National Congress of the Communist Party of China proposed to deepen the reform of exchange rate marketization. The Fifth National Financial Work Conference will deepen the reform of the RMB exchange rate formation mechanism as the primary task of expanding financial opening up. As the unilateral depreciation expectation is broken, the focus of the RMB exchange rate policy has naturally shifted to improving the market formation mechanism of the RMB exchange rate and increasing the flexibility of two-way exchange rate fluctuations. From the regular meeting of the Monetary Policy Committee in the fourth quarter of 2017, “maintaining the basic stability of the RMB exchange rate at a reasonable and balanced level” is no longer mentioned. At the beginning of the new year, the relevant parties announced the suspension of the use of the "counter-cyclic factor" and returned to the exchange rate policy neutral. This means that the focus of exchange rate regulation is not to choose the exchange rate level for the market, but to prevent excessive exchange rate or abnormal fluctuations. The observation dimension may be whether exchange rate changes cause unilateral expectations, unilateral markets, and damage to export competitiveness.

As a system neutral, exchange rate marketization itself has no and no policy preferences for appreciation and depreciation. In fact, since 2018, regardless of the sharp rise or fall of the RMB exchange rate, the central bank has abide by the policy neutrality and basically withdrew from the normal intervention of the foreign exchange market. In the first five months, exports grew rapidly, accumulating a year-on-year increase of 13.3%, which was 6.2 percentage points higher than the growth rate of the same period of last year. However, due to the import growth rate of 21%, the import and export surplus decreased by 27% year-on-year; foreign exchange supply and demand were basically balanced. The bank's long-term foreign exchange settlement and sales surplus totaled 21.4 billion US dollars, a deficit of 44.1 billion US dollars in the same period of last year; the central bank's foreign exchange account increased by 32.9 billion yuan, a decrease of 392.9 billion yuan in the same period of last year (Figure 2).
Fortunately, since 2018, the market has become more adaptable to the fluctuation of the RMB exchange rate. The exchange rate leverage adjustment function characterized by buying on dips (RMB appreciation) and selling on rallies (RMB depreciation) is functioning normally.
The recent shocks in the foreign exchange market have intensified the test of all parties

First, just as the central parity of the RMB exchange rate rose above 6.30 from March 26 to April 20, the recent rapid decline in the RMB exchange rate is also caused by market forces and does not represent the official policy orientation of the exchange rate. From June 20 to 29, the central parity of the RMB exchange rate fell by 19 cents (1931 basis points), of which the closing price was weaker than the middle price and contributed 2 points and 4 points (2,406 basis points). It can be seen that the decline in the RMB exchange rate is mainly due to the market's procyclical behavior in the event of depreciation. This can only explain that the central bank did not regulate the downward trend of the exchange rate. However, the central bank did not intervene when the RMB appreciated in the previous period, which led to the overall closing price being stronger than the mid-day price. As of June 15, the RMB exchange rate was not only 1.6%. The multilateral exchange rate (CFETS RMB exchange rate index) also appreciated by 3.2%. This symmetry is precisely the proper meaning of exchange rate marketization. The market is self-defeating, and even regards this round of adjustment as a Chinese weapon against trade frictions, and is scaring itself.

Second, in the case of management fluctuations, it is normal for the RMB exchange rate to rise and fall, and it will not rise or fall or rise. In January 2018, as the US dollar index fell by 3.4%, the central parity rate of the RMB exchange rate rose by 3.1% in a single month. At that time, the market questioned that this would affect the financial status of exporting companies and their international competitiveness. However, with reference to the adjustment of the basket currency, it has formed a seesaw effect of weaker US dollar stronger yuan and stronger US dollar weaker yuan, and passively introduced the volatility of the US dollar index in the domestic RMB exchange rate formation. In the first half of 2018, the renminbi exchange rate rose first, then fell, and the ups and downs of the ups and downs, once again proved that the short-term exchange rate trend is nonlinear and unpredictable.

Third, the economic impact of changes in exchange rate levels is a "double-edged sword". Both rising and falling have advantages and disadvantages. When the RMB exchange rate fell, the market was too bearish on the Chinese economy and bearish on the renminbi. It is hard to say that it is completely rational. This kind of market disappointment that the RMB exchange rate is not ups and downs, coupled with the excessive rendering and speculation of various media, inciting and creating market panic, is an important constraint for the RMB exchange rate to become market-oriented.
The renminbi suffers from excessive risk on the downside because "the market" doesn't think it can drop very much and it has been a low volatility currency. If the yuan experiences an unexpected decline on high volatility, it shocks the market.
Fourth, there may be a callback at any time after the exchange rate is overshoot. Recently, the RMB has fallen sharply, mainly because market sentiment has been affected by factors such as the strengthening of the US dollar index, the differentiation of Sino-US economic and monetary policies, and Sino-US trade conflicts. The overseas RMB exchange rate continued to be weaker than the domestic RMB exchange rate on June 14. The domestic RMB exchange rate closing price continued to be weaker than the middle price from June 19, causing the RMB exchange rate in the month of June to fall by 3.1%. However, market sentiment tends to deviate from the fundamentals of the economy, and it is easy to overshoot the exchange rate when the catharsis is concentrated. Since it is overshoot, it is possible to call back at any time. After we saw the results of the US presidential election at the end of 2016, the US stock market and the US dollar rose from six hours later. Also, since the beginning of 2017, the so-called Trump effect has disappeared, and the US dollar index has entered a long time. Bear way.
Some near term outlook:
First of all, there is a big market divergence in the dollar trend. Affected by higher domestic inflation, higher economic growth, higher interest rate hikes, unfavorable economic start in Europe and Japan, political turmoil in Europe and geopolitical conflicts, the US dollar has rebounded in the international market since mid-April. However, the bearish view of the US dollar believes that high US asset prices, long-term low inflation, and high US dollar operations restrict the Fed from raising interest rates, which in turn restricts the dollar's further rise; the US government's anti-globalization mercantilist, unilateralist stance, short-term and strong The dollar has formed a conflict, which may lead to de-dollarization in the long run. In addition, the US economy, interest rates, and the dollar may all be at the end of the cycle.

Second, China's economic stability and good development toughness remains to be tested. In May and May, the slowdown in China's investment and consumption growth triggered market sentiment. However, in the process of new and old kinetic energy conversion and economic shock bottoming, economic indicators are inevitable. For long-term investors who are trending, it is still an opportunity to enter. In the first five months of 2018, overseas institutions increased their government bonds and policy bank bonds by 236.9 billion yuan, a decrease of 2.3 billion yuan in the same period last year. In the first half of the year (as of June 28), the cumulative turnover of land shares of the company was bought. The increase was 160.2 billion yuan, a year-on-year increase of 66%. Even during the domestic stock market volatility in June, the cumulative net inflow was 28.5 billion yuan (Figure 5 and Figure 6).
It's very easy to predict what happens if the dollar tops and begins the first steps of its bear market journey. If the top was December 2016, then all is well. This is all a counter-trend dollar rally within a bear market, pressure on EMs will alleviate, global economic growth will accelerate. If the dollar keeps rising, then stress increases. At higher and higher levels of DXY things break. Argentina and Turkey broke with DXY in the low 90s. Who breaks if DXY goes to the high 90s? Brazil would be my guess. And then if DXY moves towards 105? At what point does the dollar rally become a self-fulfilling short-squeeze on dollar debtors?

In the near-term, the U.S. dollar is the most important factor for the market. Second is yuan depreciation expectations, which will be tied to data points such as FX reserves. Reserves in SDR will be important to watch because reserves in USD have been depreciating along with CNY.

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