Breaking 7

A critical period for the Chinese yuan is about to arrive as USDCNY approaches 7.00. The market expects USDCNY to break 7.00, but speculators aren't piling into bearish yuan bets yet. Yuan depreciation expectations remain subdued. Financial market participants generally understand that USDCNY can go through 7.00 solely because of U.S. dollar strength. Talk of trade war and "weaponized" yuan persists, but there aren't massive bets on it yet because it's widely believed the PBoC will step into the market to prevent a rapid depreciation following a break of USDCNY 7.00. The PBoC has guarded reserves with draconian capital controls. Official statements are increasing the odds that speculators will turn their attention to the yuan and put those capital controls to the test.

Reuters: Guarding stability, China likely to slow yuan's slide to 7 per dollar - sources

China is likely to use its vast currency reserves to stop any precipitous fall through the psychologically important level of 7 yuan per dollar as it could risk triggering speculation and heavy capital outflows, policy insiders said.

If the dollar bulls are right (myself included), the red line will come back to bite China. A move through USDCNY 7.00 is inevitable if the dollar keeps advancing. Should DXY clear 100 and march higher, a red line risks triggering reflexivity in the market. The market will see a falling yuan as evidence of PBoC failure, the renminbi will fall if only because it must as euro and EM currencies depreciate, this will attract hot money betting on depreciation, and the PBoC will face escalating pressure that accelerates its reserve burn.

Another red line for China was $3 trillion in reserves. It's unknown where the next red line resides, but economists estimate China may need somewhere north of $2 trillion in reserves. I agree that China needs far less reserves in most situations, but crises don't occur most of the time. They're rare, fat tail events. When push comes to shove, officials will quickly pull the plug on defending the currency. Even with a conservative target of $2 trillion in reserves as the final line in the sand, if reserves start falling as they did in 2015/2016 (or faster despite capital controls), China will have only months before it hits the line in the sand.

Two sources involved in internal policy discussions, but who are not the final decision-makers, said that a defense of the yuan at 7 per dollar would be mounted to show investors that the authorities wouldn’t allow a runaway market.

“If the yuan falls through 7, there could be a rapid depreciation of the exchange rate”, said one policy insider. “In order to avoid such a passive situation, the authorities are likely to step in the market to stabilize the yuan.”

The second source was certain the central bank would make a stand, rather than allow any sudden break through a psychologically important level to feed pessimism among investors.

“The central bank will intervene - intervene directly or indirectly. It’s necessary. The central bank has many policy tools. We cannot let the yuan fall past 7, as it would have a psychological impact on people,” the second source said.

Individual Chinese investors have trillions of yuan in savings, money markets, and WMPs looking for returns. Tight capital controls have kept their assets onshore. A rising real estate market soaked up capital, but the market is topping. The stock market holds no attraction at this moment. Poor price action has kept them from piling into gold, although the recent devaluation in the yuan and stable gold price has lifted gold's return to positive for the year. China has import quotas on gold as part of capital controls. Should money start flowing into the barbarous relic, the Shanghai gold premium could quickly become a signal of depreciation expectations.

The Starting Gun

The game is not yet afoot, but Chinese officials have signaled the game begins at USDCNY 7.00. That's when ordinary Chinese and speculators alike are expected start selling yuan in size and the PBoC is expected to step in and stop them.

I view the yuan decline (to this point) bearishly because it was not driven by depreciation expectations. The dollar was responsible for the drop until now. Instead of having a room for depreciation, the PBoC will start fighting depreciation pressure with its back to the wall. Any slip, or even letting the yuan follow the euro and EM currencies lower versus the dollar, will invite more yuan selling. Mistakes break in favor of the speculators.

The Chinese View

The Chinese government has cracked down on financial media amid the slowing economy, topping real estate market, depreciating yuan, bear market in stocks and depreciating yuan. Still, the financial media remains relatively open. Articles warning of accelerated depreciation are showing up again. Phoenix Media's (iFeng) financial news division, which was put on ice for a month, returns with an "all is well" regurgitation of PBoC talking points.

The articles below are presented in chronological order.

Sina: 专家看人民币贬值：这件事比“保7”更加重要

This year, the renminbi volatility against the US dollar has significantly increased. The pessimistic recovery of the market's depreciation of the RMB exchange rate, the "breaking 7" theory revived. However, many experts have indicated to Zhongxin Jingwei that it is better to look at the essence through the phenomenon rather than paying attention to whether it is “breaking 7” – paying attention to the RMB against the US dollar.Economic phenomena reflected in exchange rate changes and differences in trade systems between countries. At the same time, many experts stressed that the reform of the exchange rate system should be further promoted, the flexibility of the exchange rate system should be strengthened, and the market floating exchange rate system should be realized as soon as possible.

What is the impact of “Breaking 7”?

　　Previously, there were voices on the market saying that if the exchange rate of the renminbi against the US dollar is lower than 7, it means that the renminbi exchange rate is still in a controlled and stable scope; once broken, it means that cross-border capital flows, imports and foreign reserves will have different degrees of shock.

　Is there a reasonable range of RMB exchange rate fluctuations, what happens once “breaking 7”? In the view of Xiao Lizhen, chief macro researcher of Pacific Securities and deputy researcher of the World Economics Institute of the Chinese Academy of Social Sciences, when the RMB exchange rate approaches 7, there will be a large amount of short-term capital influx into the foreign exchange market to short the RMB exchange rate. If the situation at home and abroad is more serious, the short-selling funds will use the "breaking 7" signal to guide the depreciation of the RMB exchange rate.

　　Xiao Lizhen also pointed out that after repeated shocks and the RMB exchange rate approached 7 again, if there is no large amount of short-term RMB exchange rate funds in the market, the impact of “breaking 7” will be small.

...Yu Yongding, a member of the Chinese Academy of Social Sciences, recently wrote that “it is difficult to imagine that the renminbi will fall to the extent of triggering the financial crisis.” He also stressed that even if the exchange rate falls below 7, it must adhere to the non-intervention policy.

　　Yu Yongding called for "don't panic." For market participants, “don't panic” means avoiding large-scale capital flight; for monetary authorities, “don't panic” means even the dollar against the yuanIf the exchange rate falls below 7, it must also adhere to the non-intervention policy. "With this kind of patience, the reform of the exchange rate system may eventually be completed." Yu Yongding said.

wallstreetcn: 人民币贬值对经济有提振作用吗？

We find that the depreciation of the RMB exchange rate has a better correlation with the growth rate of industrial products (PPI). As can be seen from the figure below, the horizontal axis is the RMB exchange rate, and the vertical axis is the PPI year-on-year growth rate. There is a clear linear relationship between the two. After a simple fitting, the results showed that the RMB depreciated by 1000 points, the PPI increased by an average of 1.16 percentage points year-on-year, and the fitting R square was 0.428, which was basically available.

We have some intuition to explain the positive correlation between RMB depreciation and PPI. For example, the depreciation of the renminbi will bring about input inflation and be transmitted to industrial products. For another example, the depreciation of the renminbi will increase the international competitiveness of Chinese products, thereby stimulating demand and transmitting demand to prices.

Then the PPI rebounds year on year, first of all, it will improve the profit performance of industrial enterprises. As can be seen from the following figure, the growth of PPI has a significant positive correlation with the profits of industrial enterprises. Then, when the profit of the industrial enterprise is repaired, the investment will be restarted. The author believes that there has been a rebound in manufacturing investment this year, which has a greater relationship with the year-on-year rise in PPI and the high growth of industrial enterprises.

Then another important role of the PPI recovery is to promote the growth of the nominal growth rate of the economy. As we can see from the chart below, there is a strong positive correlation between the growth of PPI and the nominal growth of GDP in the secondary industry. The nominal growth of the secondary industry's GDP is the only driving force for the nominal growth of the current round of GDP in 16-17.

So how do you view this wave of depreciation since the end of May this year? As can be seen from the chart below, although the RMB has had a large depreciation trend since the end of May, the PPI has not yet recovered. The main reason is that the depreciation to PPI has a certain lag, and it can be expected that the recovery of PPI and the repair of corporate profits will be expected soon after.

However, it remains to be seen whether the PPI recovery and profit recovery will effectively stimulate corporate investment and thus prevent the economy from continuing to decline. If the economy still has downward pressure, then it is also the righteousness to continue to depreciate. This is still the role of the economy's self-regulating function, without excessive panic and interpretation.

JRJ: 离岸人民币见两年新低！持续贬值下资本外流压力加大

With the continued depreciation of the RMB against the US dollar, capital outflow pressures have reappeared.

　　On October 25, the State Administration of Foreign Exchange announced the September bank settlement and sales data show that the bank's settlement and sales deficit in September was 120.2 billion yuan, the largest deficit since June 2017. Among them, the settlement of foreign exchange settlement and sales was 110.3 billion yuan. It is the largest since February 2016; combined with the September foreign exchange reserves and foreign exchange holdings data released in the previous period, both indicate that the cross-border capital outflow situation is deteriorating and the pressure on RMB depreciation has increased.

On the day of the data release, the spot exchange rate of the RMB against the US dollar also performed poorly. Onshore, the RMB exchange rate against the US dollar closed at 6.9498, which was the lowest since January 3, 2017, down 97 points from the previous trading day. Offshore fell even more, once fell below the 6.96 mark, refreshing the latest two-year low.

Bank of China International Finance researcher at the Institute for Wangyou Xin brokerage China, told reporters that although China cross-border capital flow situation remained stable, but since the third quarter as the global financial market turmoil, the rapid devaluation of the RMB exchange rate is increasing the rusk of a sudden reversal in short-term cross-border capital flow, which in turn will increase the pressure to devalue the yuan.

...Often, bank brokerage settlement and foreign exchange payments are often seen as effective indicators of cross-border capital flows. In September, the bank's settlement of foreign exchange settlement and sales was 110.3 billion yuan, the largest since February 2016, a deterioration of 47 billion yuan from the previous month.

　　The bank's discount on the settlement of foreign exchange settlement on behalf of customers reflects the increase in capital outflow pressure. The expansion of the scale of the month's deficit was mainly affected by the apparent deterioration of foreign bank receipts and payments. In terms of sub-projects, the current account deficit was 104.1 billion yuan, and the deficit was expanded by 28.2 billion yuan. The difference between capital and financial projects was reversed to -6.2 billion yuan, down by 18.7 billion yuan from August. In September, the long-term net settlement of foreign exchange reached 1.8 billion yuan, which has been converted from net sales to net settlement.

　　“In September, the bank’s foreign exchange payment deficit widened by 160.6 billion yuan to 191 billion yuan, which was obviously worsened. Both foreign-related foreign exchange receipts and RMB cash flows were not performing well.” China Merchants Securities macroeconomic research director Xie Yaxuan said.

Finally we get to the culprit: the U.S. dollar.

It is worth noting that the reason for the apparent deterioration of foreign exchange payments on behalf of customers is that there is a new external factor change that is worthy of vigilance. In the bank's foreign exchange payment in September, the capital and financial sector turned from a surplus to a deficit, which significantly deteriorated by 136.1 billion yuan. Among them, securities investment projects have become a major drag.

　　Xie Yaxuan explained that the sharp rise in US bond yields has had a significant negative impact on global asset prices and capital flows, and China is no exception. In September, the scale of foreign-funded bond purchases showed a significant contraction, showing a 93% drop from a month earlier.

　　More importantly, the above negative effects may continue to ferment in the coming months. "The long-term spread between China and the United States has now dropped to a historical low of around 40bp, and the exchange rate factor is also unfriendly. In the context of both negative factors turning negative, the size of foreign debt purchases in the coming months will likely The decline has a certain negative impact on China's capital flow situation, the RMB exchange rate, and the performance of the bond market,” Xie Yaxuan said.

Analysts believe the People's Bank of China started intervening in September (also possible, the bill for intervention in late June came due). Marketwatch, back on June 27: China's central bank steps in as yuan tumbles. If China used 3-month forward contracts, the bill would have come due at the end of September.

As for reserves and net outflows, the risk right now isn't that dollars start flowing out in larger amounts, but that dollars stop flowing in.

All kinds of signs indicate that the pressure on China's current cross-border capital flows is increasing. Wang Youxin said that although the current situation of cross-border capital flows in China remains stable, the risk has risen with the rapid depreciation of the RMB exchange rate since the third quarter. This is mainly reflected in the following three aspects:

　　First, the difference in the settlement and sale of bank valet in the last three months has once again been reversed, and the scale of bank foreign exchange receipts and payments has expanded. Since the third quarter, the bank's valet exchange rate has also fluctuated as a whole, and the willingness to settle foreign exchange has declined. In the same period, the bank's foreign exchange payment deficit has gradually expanded.

　　Second, the net inflow of non-reserve financial accounts has declined rapidly, and the third quarter may be reversed. The net inflow in the first quarter was close to $100 billion, and the second quarter quickly fell back to $30 billion. Since mid-June, the depreciation of the RMB exchange rate has accelerated, and cross-border capital flows will be subject to more severe challenges. The non-reserve-type financial accounts in the third quarter are likely to show a deficit again.

　　Third, the short-term cross-border capital inflows under the securities investment increased. In the context of increasing global financial volatility, the future may become a potential risk point.

Unless fundamentals change, everything is pointing to renminbi depreciation:

"If the narrowing of the spread is carried out along the line of 'China-US spread narrows - capital inflows into the US - the dollar strengthens and the yuan weakens," this will mean that China's capital will likely further outflow. Capital outflows will increase. This means that the renminbi demand is weakening, and the pressure on the RMB exchange rate is increasing.” Ming said that given the current downward pressure on the domestic economy , monetary policy may be further loosened. Correspondingly, the probability of tightening the currency exchange rate is small.

Liu Shijin , a 　　member of the central bank's monetary policy committee, recently pointed out that he should face up to the dynamic adjustment of the exchange rate equilibrium level and maintain the basic stability of the RMB exchange rate at a reasonable and balanced level. Whether it is "breaking 7 theory" or "guarantee 7 theory", it is important to ignore that equilibrium is dynamic. The equilibrium level of the renminbi is not static. It should adapt to the dynamic adjustment of the renminbi equilibrium level, enhance the flexibility of the exchange rate, give play to the fundamental role of the market's automatic equilibrium, and maintain the basic stability of the renminbi at a reasonable and balanced level.

　　"In response to the social concerns about the depreciation of the renminbi and the idea of ​​holding a 'gate', we believe that the important thing is not the specific 'point', the key is that the exchange rate mechanism should be correct. As long as the mechanism is correct, it is not afraid that the 'point' will not come back. Liu Shijin said.

Liu Shijin is right, but officials are sending the opposite signal.

Finally, here's the latest from iFeng, the top article in their out-of-the-penalty-box finance section: 一度逼近十年汇率低点！央行喊话人民币应声回升

Yesterday, Pan Gongsheng, deputy governor of the People's Bank of China and director of the State Administration of Foreign Exchange, stressed at the briefing of the State Council policy that the fundamentals of the Chinese economy are stable, the macro leverage ratio is basically stable, and the financial and financial risks are generally controllable. Generally balanced, sufficient foreign exchange reserves. These factors provide fundamental support for the RMB exchange rate to remain basically stable.

"We have the foundation, ability and confidence to maintain the basic stability of the RMB exchange rate at a reasonable and balanced level." Pan Gongsheng said.

...Pan Gongsheng said yesterday that the recent changes in the RMB exchange rate are mainly reflected in market supply and demand and international exchange market fluctuations. The depreciation of the renminbi is the result of a combination of factors such as the US dollar interest rate hike, the US dollar index, international financial market disruption and trade friction.

...Pan Gongsheng pointed out that the People's Bank of China has actively taken some measures to stabilize expectations, such as constantly improving the mechanism of the RMB exchange rate marketization and maintaining the flexibility of the exchange rate. At the same time, it has also been and will continue to actively adopt macro-prudential policies and measures in response to the procyclical behavior of the foreign exchange market. Stabilizing foreign exchange market expectations.

"We have the foundation, ability and confidence to maintain the basic stability of the RMB exchange rate at a reasonable and balanced level." Pan Gongsheng said.

In response to exchange rate and foreign exchange market volatility, he stressed that the People's Bank of China and the foreign exchange bureau have accumulated rich experience and policy tools in recent years, and will take necessary and targeted measures in the future according to changes in the situation.

Everything to this point has been phase one of a global cyclical turn. The drop in U.S. equities represents the end of the beginning as U.S. markets play catch-up. Round two involves breaking major multi-year trendlines such as multi-year support on major equity indexes (in some cases back to 2008 or earlier) and key resistance levels for exchange rates, including the multi-year high on the U.S. Dollar Index. The renminbi will be front and center as this transition unfolds.