2018-07-20

Here Come Depreciation Expectations: Odds of Hitting USDCNY 7 This Year are Great

A top finance section headline over at iFeng.

iFeng: 人民币汇率3天连破10道关口 分析称年内破7概率较大 (The RMB exchange rate has broken through 10 points in 3 days, Analyst says odds of breaking 7 this year relatively high)
More importantly, the spread between onshore and offshore continued to widen as the exchange rate of the RMB against the US dollar accelerated. It once expanded by nearly 400 points. The continued widening of the exchange rate spread between the two sides of the strait indicates that the current RMB depreciation is expected to be strong. At present, more and more people believe that the probability of the RMB exchange rate against the US dollar breaking 7 is greater during the year.
Three major pressures on the renminbi

In the future, if the RMB exchange rate continues to accelerate its depreciation, the market's depreciation expectation will continue to deteriorate, and the central bank will also intervene in a timely manner with great probability . On the other hand, considering the news of the increase in credit release released by the central bank and the Banking Regulatory Commission yesterday, the “wide currency + tight credit” policy portfolio turned to “wide currency + wide credit”, credit expansion restarted, and the monetary environment will be neutral. Song, China’s monetary policy is increasingly diverging from US monetary policy. In this context, the RMB exchange rate is further under pressure, how will the market and monetary authorities “wrestle”? The uncertainty in the outlook has increased.
In late 2015/earliy 2016 China boosted credit growth and CNY kept falling as depreciation expectations were rising amid a U.S. dollar rally. Outflows ceased and inflows (along with appreciation of reserve assets in USD) resumed as the U.S. dollar peaked and reversed.
Pressure 1: Depreciation expectations strengthen

A common indicator of the market's expectation of the RMB exchange rate trend is the price difference between CNH and CNY.

Guan Tao, a senior researcher at the China Financial Forty Forum, said that judging whether the market is expected to differentiate or not can firstly see that the price difference between CNH and CNY is not big. If it expands, it means that the imbalance between supply and demand is more serious, and the unilateral depreciation is expected to increase. Then see if the deviation of this spread is in one direction and continues in one direction, it is regarded as a unilateral expectation.

In recent days, the spread between CNH and CNY has continued to expand, once expanding by nearly 400 points, and today's spreads have remained above 200 points most of the time. "The foreign exchange difference between the two days is relatively large, because the offshore market is more market-oriented and less regulated, and it is usually more representative of the market's true will." A foreign exchange analyst at Beijing's big bank told reporters.
The PBoC has to defend CNH. It controls CNY, but everyone knows that. CNH is the real price. The IMF explained the CNH's role in a 2012 paper, covered in this post: The Informational Power of the Offshore Yuan Exchange Rate
Pressure 2: the settlement and foreign exchange surplus narrowed by nearly 90%

The performance of bank settlement and sales remittances reflecting the willingness of the market to purchase foreign exchange and foreign exchange settlement is also not optimistic. Despite the June data released by the State Administration of Foreign Exchange today, the bank's bank settlement and sales surplus was 13.1 billion yuan, which was the third consecutive month of surplus, but the size of the surplus dropped by nearly 90%. In the same period, the bank's forward net sales of valet was 88.7 billion yuan. The above data shows that since the renminbi entered the rapid depreciation channel in June, the cross-border capital flow situation has also been fine-tuned.

However, before this, due to the overall stabilization of the RMB exchange rate in the first half of the year, the cross-border capital flow situation is improving. Wang Chunying, director of the International Payments Department of the State Administration of Foreign Exchange, said that overall, China’s foreign exchange supply and demand were basically balanced in the first half of the year, the willingness of enterprises to purchase foreign exchange declined, and the situation of foreign exchange financing became more stable. The exchange rate increased, and the market participants’ overall willingness to hold foreign exchange decline.

However, with the entry into June, the exchange rate of the RMB against the US dollar has turned sharply, from the appreciation of the first half of the year to a rapid depreciation, and has all retreated in the first half of the year. Can the cross-border capital flow situation in the second half of the year maintain a good momentum in the first half of the year? It is worth continuing to observe.
Reserve growth tracks with the direction of DXY. Rising, reserves fall. Falling, reserves rise. It's all USD.
Pressure 3: the dollar index trend is expected to differentiate

According to the current pricing mechanism of the central parity of the RMB against the US dollar, the trend of the RMB against the US dollar depends largely on the trend of the US dollar index. That is, the US dollar is stronger and the RMB is weaker. The US dollar is weaker and the RMB is stronger. Therefore, the future trend of the US dollar index is crucial to the impact of the RMB exchange rate.

In this regard, Guan Tao said that it is still difficult to judge. There are different opinions on the market now. At present, the factors supporting the strength of the US dollar are the ones. First, the progress of the normalization of US monetary policy is relatively advanced. However, the interest rate level in the United States is now 1.75%, close to normal levels, and the rate hike is expected to come to an end. The spread between the US two-year and ten-year Treasury yield levels has gradually flattened, and there is a view that the economic cycle is nearing completion.

The second factor comes from other markets such as Europe. Because foreign exchange is a price relationship between one currency and another, the dollar was weak last year, mainly because the European economy exceeded expectations. However, since the beginning of this year, the European economy has not been particularly ideal. At the same time, political instability in Italy and Spain has occurred, and the euro has fallen more. The future does not know whether the European economy will resume its upswing, and whether the political turmoil in Europe can be alleviated.

As Cheng Tao said, the current market is not divided into the pre-judgment of the trend of the US dollar index. However, precisely because of the expected differentiation of the US dollar trend, there is also a view that the exchange rate of the RMB against the US dollar will fluctuate in both directions in the future, but the fluctuation will increase.
If the rise in the dollar triggers a disequilibrium in CNY, then CNY could begin fueling a rising USD that in turn weakens CNY. China, and the rest of the world, slides into a currency market crisis.

Businesses are advised to hedge currency risk rather than betting on the trend.
Enterprises should do the exchange rate hedging in time to avoid the exchange rate "streaking"

Based on the current market view, everyone is different on the expected trend of the US dollar, and thus has different views on the RMB exchange rate. However, the current voice of further depreciation is more mainstream.

However, given the increasing complexity of domestic and foreign factors affecting the exchange rate trend, the uncertainty of the RMB exchange rate trend is also increasing. Therefore, from a more pragmatic point of view, the more rational insurance approach for import and export companies is to do a good job of hedging the exchange rate, rather than unilateral depreciation or appreciation of the exchange rate. In particular, those short-selling forces that gamble on the unilateral depreciation of the renminbi have witnessed the series of operations of the central bank after the "811" exchange rate reform. It should be known that the power of the exchange rate management policy in the hands of the monetary authorities should not be underestimated.

Guo Shuqing, chairman of the China Insurance Regulatory Commission, said recently that the RMB exchange rate has adjusted to a reasonable range of two-way fluctuations since last year's adjustment. The economic fundamentals determine that there is no possibility of a significant depreciation. As a new international reserve currency, the future of the renminbi will tend to strengthen overall. In the past 30 years, residents and enterprises that have seen the renminbi, snapped up and held foreign exchange for a long time have suffered great losses. In recent years, some international speculators have tried to make a huge profit by shorting the renminbi. It turns out that they have seriously misjudged the situation.

In addition, as the vice president of the central bank, Pan Gong, said, in the context of increased exchange rate volatility, market players should establish a financial neutral concept. In the past two years, after the education and baptism of the market, the awareness of Chinese companies' risk aversion has improved, but overall the risk aversion is not strong. The “streaking” behavior of enterprises in the foreign exchange market is not only macroscopically due to the herd effect of market entities, but also easily causes market resonance, and at the micro level, enterprises face large exchange rate risk exposure. Therefore, with the marketization of the exchange rate formation mechanism, the volatility of the exchange rate is gradually increasing. The foreign exchange management of enterprises should adhere to the principle of serving the main business and adhere to the financial neutrality. Use the tools of the foreign exchange market to carry out hedging and reduce the bet on the unilateral increase in value.
The government says all is well. The exchange rate is stable.
Foreign exchange bureau: maintaining the stability of the foreign exchange market and ensuring the safety of foreign reserves

For the next step of cross-border capital flow, Wang Chunying admits that he is very concerned about Sino-US trade frictions, and the future evolution needs to be continuously observed. However, in the past few years, the SAFE has further accumulated management experience in responding to external pressures and enriched policy tools. In the future, we will continue to adhere to the general tone of steady progress:

On the one hand, deepen the reform of foreign exchange management and promote the two-way opening of financial markets. On the other hand, safeguarding the stability of the foreign exchange market, preventing the risk of cross-border capital flows, ensuring the security, flow, value preservation and value-added of foreign exchange reserves, and safeguarding national economic and financial security.

Wang Chunying emphasized that in general, the economic fundamentals and policy fundamentals closely related to the operation of China's foreign exchange market are still stable, and China's cross-border capital flows and foreign exchange market operations are generally stable.
In a crisis, China will be faced with a choice. Defending the exchange rate could risk exhausting its reserves. It is at that moment that the odds of a large one-off depreciation will soar.

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