Set Your Watch to Yuan Depreciation

As has been speculated by not a few bears, outflows have been running at a high pace, but intervention has masked the magnitude.

ZH: Goldman Reveals How China Is Covering Up Hundreds Of Billions In Capital Outflows
However, not even this was enough to mask the massive outflow of capital leaving China's economy and being parked offshore.

So what did China do? Why it resorted to the oldest trick in the book: fabricating data outright. Only... it was caught again. As Goldman calculates, cross-border yuan flow in recent months could have masked the true level of outflow pressure in China. According to the bank, SAFE data on onshore FX settlement show outflow of about $2b in May; was also $24b in RMB flow to offshore, meaning underlying outflow in May could be $26b, analysts including MK Tang and Maggie Wei write in a note released overnight.

More notably, they calculate that since October total net FX outflow has been about $500 billion, which is 50% above $330b implied by SAFE’s onshore FX settlement data.

They adds that there are no obvious market forces to explain RMB flow in recent months, adding that non-commercially driven factors seem a more likely explanation. They note that it is possible that offshore clearing banks or Chinese entity have been buying CNH and selling back onshore; this is justified by near-daily anecdotes of frequent CNH smoothing operations by Chinese institutions. As a result, flow to offshore doesn’t show in foreigners’ holdings of CNH assets.

Goldman also observes that since the August yuan "reform", CNH has been generally weak; but this hasn’t led to net flow from offshore to onshore. “In a stark contrast, the relationship is in total reverse since October last year - the cheaper the CNH (vs CNY), the greater the net flow of RMB from onshore to offshore.”
The bolded portion makes complete sense if market expectations are for depreciation. From The Informational Power of the Offshore Yuan Exchange Rate, quoting an IMF paper:
When CNH trades at a premium to CNY, arbitrage takes an average of 25 days to close half the gap back to the band (the “half life”) (Table 1). Capital outflows from the mainland are needed for this arbitrage, and work to increases the supply of offshore renminbi liquidity. This was the case in the November 2010-May 2011 episode.

When CNH trades at a discount to CNY, arbitrage takes an average of 6 days to close half the gap back to the band. This involves capital inflows to the mainland, reducing the supply of offshore renminbi liquidity. This was the case in September 2011-October 2012 period.
As I noted in that post, this is partially due to capital controls, but also due to the bull market. Arbitrage took longer to close because bulls didn't want to sell. Now the market sentiment is reversed. CNH is cheaper than CNY, but the arbitrage isn't closing rapidly because further devaluation is expected, more money is trying to get out than get in. As I concluded in The Informational Power of the Offshore Yuan Exchange Rate:
When the market is operating under normal conditions, everything seems to indicate yuan strength and China has tight controls on inflows to slow yuan appreciation. But if the market is not normal— if there are no bidders for yuan, but instead a growing demand to hold dollars both onshore and offshore— the offshore yuan is free to tumble. And if CNH tumbles and the financial system sees a dollar shortage, the PBOC has to follow CNH lower to bid the dollars back or it has to spend its dollars (or let them be spent by banks and citizens) to halt the decline in CNH.
Back to the Goldman report:
Regarding the first chart, I covered the fall in offshore deposits and the move to demand deposits here: The Nationalization of the Yuan

Finally from GS:
Goldman notes that in this context, "there have been market anecdotes on frequent offshore CNH smoothing operations by Chinese institutions." Actually, not anecdotes: those are all too daily, all too real interventions by "large banks" who keep a barrier on both the CNY and CNH from moving far beyond 6.65. It is precisely in these "streamlining" operations that this massive "outflow" is hidden.

Summing it all up, the reality is that instead of $330 billion in FX outflows since October, the real number is 50% greater, or half a trillion, which also suggests that instead of getting better, China's capital outflow situation is as bad as it has been, and not only that, but the government is now actively covering up the reality.
The PBoC is literally buying time in the hopes the flows end. Jeffrey Snider has discussed this: The Remarkable Accuracy of The Ticking Clock
What that meant was the same old situation setting up for a third time. The PBOC interventions could only buy time, meaning some variation of a three-month window. Because, as the IMF finally pointed out, we are in the dark about all of this we can’t really know much apart from the basics of the interbank construction. The “clock” calibrates to 3 months, but from what point does it actually start counting down? It was always most reasonable to assume it would begin where something changed. In CNY, that was surely early January as the exchange rate flashed down to 6.60 and then abruptly stopped.
If there is something truly missing, it is so far CNH or offshore yuan. It was almost the defining characteristic of the PBOC’s helplessness during the prior two episodes; so much attention was paid to “speculators” trading CNH in Hong Kong that it missed these important interconnections. Since mid-February, CNH has been a most placid and conforming market – which can only mean intervention. Recent trading has begun to hint at the end of that “window” as well (subscription required).
Don't forget the recent rumor that the Chinese Govt Might Take Yuan to Red Line in 2016 (USDCNY 6.8). We might see another drop below 6.70 in July (although it's possible the recent spike is the end of the move) followed by another intervention that props up the yuan until at least early September, followed by the next move to 6.8 or so. That appears to be the plan. They key, as always, will be the U.S. dollar. If it weakens, life is easy for the PBoC. If Europe runs into financial trouble and the U.S. Dollar Index takes off again.
That wee bit heap o' leaves an' stibble,
Has cost thee mony a weary nibble!
Now thou's turn'd out, for a' thy trouble,
But house or hald,
To thole the winter's sleety dribble,
An' cranreuch cauld!

But, Mousie, thou art no thy lane,
In proving foresight may be vain;
The best-laid schemes o' mice an 'men
Gang aft agley,
An'lea'e us nought but grief an' pain,
For promis'd joy!

Still thou art blest, compar'd wi' me
The present only toucheth thee:
But, Och! I backward cast my e'e.
On prospects drear!
An' forward, tho' I canna see,
I guess an' fear!

1 comment:

  1. What's your target? also won't depreciation ultimately be good for other rmb denominated assets like A shares and China RE?