China Cuts RRR 1pc, USDCNY Breakout to Follow Despite Govt Assurances

The relationship between RRR and CNY is fairly straightforward because the Chinese monetary system remains heavily reliant on U.S. dollar liquidity. When U.S. supply is expanding, the PBoC increases the RRR to soak up liquidity. When U.S. liquidity is tight, the PBoC cuts the RRR. This latest cut should unleash a rally in USDCNY towards 7 and then a breakout to the upside.

Nikkei: China slashes banks' reserve requirements as trade war imperils growth

China's central bank on Sunday announced a steep cut in the level of cash that banks must hold as reserves, stepping up moves to lower financing costs and spur growth amid concerns over the economic drag from an escalating trade dispute with the United States.

The reserve requirement cut, the fourth by the People's Bank of China (PBOC) this year, comes as Beijing has pledged to expedite plans to invest billions of dollars in infrastructure projects as the economy shows signs of cooling further, with investment growth slowing to a record low.

Reserve requirement ratios (RRRs) -- currently 15.5 percent for large commercial lenders and 13.5 percent for smaller banks -- would be cut by 100 basis points effective Oct. 15, the PBOC said, matching a similar-sized move in April.

Economists predicted further cuts ahead.

There were no trade wars in 2008, 2011 and 2015. There was dollar pressure. It has returned in 2018. Trade war is another straw on the camel's back, but the dollar is the far greater concern. Even without trade war, China would be cutting its RRR.

Official Response

The People's Bank of China and SAFE both issued statements defending the currency today, but they doth protest too much. While the move is not intended to weaken the yuan, it will weaken the yuan. China is in an unenviable position, albeit one of their own making thanks to years of dragging their heels, because actions they take to prop up the economy will increase depreciation pressure on the yuan.

People's Daily: 央行：降准释放约7500亿增量资金 不会对人民币形成贬值压力

Whether the RRR cut will increase the pressure on the RMB depreciation, the above-mentioned person in charge said that this RRR has made up for the liquidity gap of the banking system, optimized the liquidity structure, and the monetary policy has not relaxed. The market interest rate is stable, the broad money (M2) and The growth rate of social financing scale is basically matched with the nominal GDP growth rate, which is reasonable and moderate, and will not form depreciation pressure. This RRR cut is conducive to promoting economic restructuring and promoting high-quality development. The economy is basically facing the consolidation of the RMB exchange rate. As a large-scale developing economy, China's exports have strong competitiveness. At the same time, China's economy is dominated by domestic demand, manufacturing industries are complete, industrial systems are relatively complete, import dependence is moderate, and the RMB exchange rate has sufficient conditions to maintain a reasonable balance. Basically stable at the level. The People's Bank of China will continue to take necessary measures to stabilize market expectations and keep the foreign exchange market running smoothly.

People's Daily: 外汇局：外汇储备规模有望在波动中保持稳定

Wang Chunying, spokesperson of the State Administration of Foreign Exchange, said that in September, China's foreign exchange market continued to maintain a stable overall trend, and the market participants' foreign-related transactions were more rational and orderly. In the international financial market, the US dollar index was basically the same as that at the end of August. The main non-US dollar currency exchange rate has risen and fallen, and the price of major national bonds has fallen slightly. The combination of exchange rate conversion and asset price changes has led to a slight decline in the size of foreign exchange reserves.

　　Wang Chunying said that since the beginning of this year, in the face of the complicated external environment, China has adhered to the general tone of steady progress, deepened the reform and opening up, maintained a generally stable and stable economic situation, continued to optimize the economic structure, and flexible the two-way fluctuation of the RMB exchange rate. The company continued to strengthen, the balance of payments was basically balanced, and the scale of foreign exchange reserves remained generally stable.

　　Looking forward to the future, Wang Chunying said that although the external environment still faces great uncertainty, China's economy has strong adaptability and ability to withstand external risks. The sound fundamentals will continue to provide a solid foundation for the smooth operation of the foreign exchange market. The comprehensive role of domestic and foreign factors, China's foreign exchange reserves are expected to remain stable in the volatility.

China announced its change in forex reserves today as well.

Xinhua: China's forex reserves edge down in September

China's foreign exchange reserves edged down 0.7 percent, or 22.7 billion U.S. dollars from a month earlier, to 3.087 trillion U.S. dollars by the end of September, the central bank said Sunday.

Wang Chunying, spokesperson of the State Administration of Foreign Exchange, attributed the contraction to a number of factors including exchange rate conversion and changing asset prices.

"Bonds usually take up a large portion of many countries' forex reserves," said Zhao Qingming, chief economist of derivatives institute of China Financial Futures Exchange. "The interest rate hike by the Federal Reserve has led to declines in bond prices across the world, which also influenced the assest reassessment of China's forex reserves."

In addition, Japanese yen weakened over 2 percent, resulting in write-downs in the yen assets China held with its forex reserves.

According to Zhao's estimates, China's forex reserves lost about 10 billion U.S. dollars in book value because of the weakening of yen.

This is the price of dedollarization. China has diversified its assets and many of those assets are depreciating. USDJPY has broken out to the upside and EURUSD is threatening to breakdown.

Chinese reserves depreciated $22.7 billion, but only SDR 6.5 billion. The SAFE spokesman is correct in blaming forex movements, but this is only good news if you are neutral to bearish on the U.S. dollar. If the U.S. dollar breaks out, Chinese reserves will depreciate. The risk of capital controls failing, a speculative attack or depreciation expectations running wild on the Mainland become increasingly dangerous risks as reserves dwindle.

Even without a crisis in China, a move through USDCNY 7.0 will intensify pressure on Chinese trade partners. The real pain for emerging markets has yet to begin.