Chinese Hoarding Dollars Again

21st Century: 境内外人民币汇率双双创年内新低 跨境汇差套利交易再度活跃
Sogou: Both domestic and overseas RMB exchange rates hit a new low in the year, and cross-border arbitrage trading resumed

While the Sino-US trade friction has not yet been eliminated, the sudden rise of the US dollar has once again put new downward pressure on the RMB exchange rate.

In my opinion, there is very little evidence of trade friction in the markets right now. Maybe I'm wrong and the S&P 500 should be near 3200, with talk of Dow 30,000 picking up, and current prices are the result of trade friction. My sense is many people still believe a deal is coming, they believe Trump will not risk economic pain or stock market declines. On the other side of the ledger, I continue to expect this cycle will end with currency devaluation across the world, including or set off by the Chinese yuan, ending with DXY at a two- or three-decade high. Going back to the Logic of Strategy post, I expected an economic crisis in China would trigger trade friction, not vice versa.

In his view, this does not mean that the RMB exchange rate will quickly approach the "7" integer mark. The reason for this is that unlike last September's escalation of Sino-US trade friction, when the offshore one-year RMB exchange rate was expected to fall by more than 1,000 basis points, the current offshore one-year RMB exchange rate is expected to fall by only 500 basis points, which indicates that most overseas investment institutions believe that the pressure of the Central Bank of China to intervene in the foreign exchange market will make it difficult for the RMB exchange rate to effectively fall below the "7" integer mark in the future.

"This is very helpful to solve the problem of clearing the foreign exchange market. As long as the RMB can hold the 7-integer mark, the arbitrage of hoarding USD by many enterprises will gradually ebb, indirectly supporting the momentum of stabilizing the RMB exchange rate. " A head of the financial market department of a joint-stock bank admitted frankly to the reporter.

..."More importantly, good economic data in the United States has led hedge funds to sharply lower the Fed's expectation of cutting interest rates this year, thus strengthening the US dollar short covering." A U.S. hedge fund manager told reporters, "hedge fund's move is definitely not good for stabilizing the RMB exchange rate-the RMB exchange rate both at home and abroad showed a rapid decline on the 17th due to the impact of the jump in the U.S. dollar index."

This type of thinking is exactly why I worry about USDCNH going through 7.00. Many believe it won't despite understanding that the U.S. Dollar is driving the market. You can be near certain a break of 7 will not happen if you are certain the U.S. Dollar has no more than 2 percent upside left. Otherwise, uncertainty is high.

Additionally, it's important to keep in mind how CNY and CNH work with each other. In simple terms, the PBoC can set CNY where it wants and force the domestic market to buy and sell at this price. There are limits of course, they can't go too far above or below without risking major distortions or black markets, but if there was no CNH they would have far more power to set the exchange rate.

CNH introduces a new variable. When CNH is above CNY (the offshore yuan is stronger than onshore), it indicates capital flowing into China and into the yuan. If you're in Mainland China, you bring your foreign currency into China because you can buy yuan cheaper than in Hong Kong. Arbitrageurs will bring FX into China, buy CNY, and sell CNH in Hong Kong.

When CNH falls below CNY, it creates a bigger headache for the PBoC. First there is the reverse arbitrage, buy USD with CNY in China, then buy CNH in Hong Kong. Instead of having unlimited CNY to stop appreciation, there is limited reseves with which to defend the currency. Additionally, exporters can divert their capital from Mainland China. Instead of bringing capital home, they exchange it for CNH overseas or they leave foreign exchange in foreign banks hoping for even better prices in the future. Since capital controls are tight on the Mainland, falling CNH and rising depreciation expectations will divert capital away from China. Capital controls can also be avoided with cryptocurrency or through more expensive methods such as real and fake exports.

At present, foreign trade enterprises and overseas investment institutions are mainly involved in domestic foreign exchange arbitrage. They mainly use the name of cross-border trade settlement to purchase foreign exchange according to the domestic exchange rate to pay cross-border trade payments to affiliated enterprises, which will then take the US dollar position to the overseas offshore market for foreign exchange settlement for more RMB. After deducting relevant transaction costs, the risk-free foreign exchange earnings generated by the cross-border foreign exchange arbitrage exchange since last week exceed 1 percentage point.

At the same time, the cross-border arbitrage of foreign exchange difference has led to a sudden increase in domestic demand for foreign exchange, which has virtually put more downward pressure on the RMB exchange rate in the onshore market.

At present, he is most worried about the reactivation of cross-border arbitrage, which will lead to the offshore exchange rate "dominating" the current RMB exchange rate trend. If overseas speculative capital seizes this opportunity to "artificially" expand the range of domestic foreign exchange differentials by significantly depressing the offshore RMB exchange rate and stimulate the continuous fermentation of domestic foreign exchange differential arbitrage transactions, it may drag the RMB exchange rate close to the "7" integer mark in the short term.

"To reverse this situation, the relevant departments should not only take targeted intervention measures to reduce the foreign exchange gap in China at the necessary moment, but also choose the right time to intimidate speculative capital and prevent speculative short selling from continuing to ferment." This Hong Kong bank foreign exchange trader believes that.

The PBoC will wait for the right moment to burn the shorts, to get the biggest bang for their bucks.

Enterprises hoard U.S. dollars
With the RMB exchange rate falling below the 6.9 integer mark, more and more companies are hoarding USD positions for arbitrage.

The chief financial officer of a large domestic foreign trade enterprise disclosed to reporters that compared with the same period last year, the enterprise has retained more than 6 million US dollars in position, because the head of the enterprise thinks that the Sino-US trade friction may cause the RMB exchange rate to break "7" in the short term, and then the enterprise can exchange foreign exchange and exchange more RMB.

"Since this week, quite a few foreign trade enterprises have taken similar actions." The head of the financial market department of the above-mentioned joint-stock bank pointed out to the reporter. The reason why foreign trade enterprises hoard dollar positions is not necessarily to bet on the decline of the RMB exchange rate to take more RMB, but also to consider "preparing for a rainy day" for future foreign payment of USD-if the RMB exchange rate continues to fall, these enterprises have to reserve dollar positions in advance to reduce exchange risks, and also have to take into account the tightening of cross-border capital flow supervision measures, resulting in enterprises unable to pay USD on time.

In his view, this has led to a resurgence of the problem of clearing the foreign exchange market. In particular, when the demand for foreign exchange settlement in the market continues to fall below the demand for foreign exchange purchase due to the recent hoarding of US dollars by enterprises, the RMB exchange rate has again shown an inertial downward trend due to its inability to digest the "foreign exchange purchase order".

Andy Wester revealed that as long as the RMB exchange rate fell below the 6.9 integer mark in the past three years, the problem of clearing the foreign exchange market would follow one after another, causing the RMB exchange rate to drop rapidly to around 6.97-6.98 in the short term. This time, some speculative capital did not rule out taking this as a warning and took the short selling method of betting on the rapid decline of RMB to "draw chestnut from fire".

"The most effective way to solve the current problem of clearing the foreign exchange market is for the Central Bank of China to directly intervene in the foreign exchange market, breaking the expectation that enterprises and speculative capital are betting on the RMB to break 7. As a result, if companies fail to hoard U.S. dollars for arbitrage, they will turn to quickly settle and stop losses when the RMB exchange rate rebounds, and the relationship between supply and demand in the foreign exchange market will also tend to be balanced and stable, thus laying a firmer foundation for the stabilization of the RMB exchange rate. " The head of the financial market department of the above-mentioned joint-stock bank believes that.

The PBoC has two problems in defending the yuan. One is that it cannot control EURUSD, USDJPY, USDAUD, etc. Thanks to dedollarization efforts, a dollar bull market can chip away at those reserves indirectly. Second, USDCNY 7.00 has become a thing and it is less than 1 percent away. If the dollar is rising and speculators want to press their bets, the PBoC will have to spend.

Maybe concerns are overblown again. Maybe the U.S. dollar is peaking or has peaked. Maybe a trade deal is coming. If not, could be a lot of surprised people saying: