Recent Weakening In China Renminbi
With the CNY weakening by 2.8% against the USD month-to-date (as of 26 June 2018), the steepest fall since August 2015, it is driving investor attention on whether it is the Chinese authorities' intention to devalue the local currency as a retaliation tool.
However, we believe that it is still too early to conclude that the Chinese government has a bias towards a much weaker RMB.
RMB has depreciated more sharply against USD but less so against a basket of currencies
The chart below shows that USD/CNY (white line) has been moving largely in line with the Dollar (DXY) Index (green line) YTD. In fact, the USD strengthened to a lesser extent against CNY in April and May. Until the past few days, the CNY depreciated quite sharply against the USD even the Dollar Index was steady. How about the RMB Index (against a basket of currencies)? The RMB Index (yellow line) has been on a slight appreciation trend YTD. The RMB Index still showed a mild appreciation in 1H June, but a mild depreciation since then.
In fact, by looking at the CFETS fixing rate over the past few days, the fixing rates were stronger than the market-driven spot rates, which seems to suggest that the recent depreciation has not been driven by the PBoC. Also, a moderate CNY depreciation vs USD is in-line with our slightly negative 12-month view on the local currency.
3 key reasons on recent RMB depreciation pressure:
- China macro indicators have moderated in recent months, while US economic momentum remains strong. This has led to the divergence of monetary policy between China and the US, and in turn, the narrowing of interest rate differential. China has been easing gradually by cutting Reserve Requirement Ratio (RRR), while the Fed is on track to raise interest rates. A narrower interest rate differential tends to translate into a weaker RMB historically amid capital outflow pressure.
- China's current account registered its first quarterly deficit in 1Q 2018 in nearly 17 years, while ongoing Sino-US trade tensions could result in weaker exports and a falling trade surplus
- Seasonal outflows on dividend payout by Chinese corporates in the mid-year
Why currency devaluation may not be a good retaliation tool?
Significant depreciation in RMB could undermine domestic households and business confidence in the local currency and revive capital outflow pressures at the time when the country's financial deleveraging is still in place and the onshore credit and liquidity condition remain tight despite the RRR cuts in recent months.
If the Chinese administration were to proceed with CNY devaluation, this would likely require changes in the CNY policy framework which could create credibility risks, especially in light of Beijing's internationalization policy to open its onshore bond markets.
There are still plenty of retaliatory options. Apart from retaliating against major US exports, China could clamp down on business with US companies, hit back at US investments in China, and limit purchases of US products by the local governments and domestic companies etc.
Sell-off in China equities despite solid corporate earnings growth
China equities experienced a brutal selloff over the past 2 weeks. Market sentiment has deteriorated very rapidly. Fears over escalating trade frictions with the US as well as tightening onshore liquidity condition due to continued domestic deleveraging are the major culprits. The market is looking oversold in the short term though sentiment is yet to recover. As we mentioned previously, market volatility will stay over the summer as the trade tension is likely to get worse before it gets better. The PBoC's more proactive policy easing stance could also help alleviate some concerns over tightening liquidity. With valuations of China equities becoming more attractive and corporate earnings growth at double-digit, we still believe the corrections offer good medium-term buying opportunities after the dust settles.