November 14, 2019

Renminbi sticking to well trodden path

BY Olivier Desbarres

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( 6 mins)

We noted in “Renminbi depreciation true to form” (6 June 2019) that history was repeating itself, with the Renminbi NEER having weakened in April-June as it had done in May-July 2018, albeit at a more modest pace (see figure 1). This was a clear indication in our view that “Chinese policy-makers were once again using Renminbi depreciation as both a weapon in the trade war with the US and a tool to reflate the Chinese economy”.

Moreover, we argued that the risk near-term was that the Renminbi would weaken further and between 6 June and late-August the Renminbi NEER depreciated 2.7% to a five-year low – a similar pace of depreciation as recorded between mid-July and mid-October 2018.

The Renminbi NEER was then range-bound between late-August and early-October before making incremental gains in the second week of October on news of a thawing in US-China relations and progress made in negotiations in “Phase 1” of a bilateral trade agreement.

The Renminbi NEER appreciated a further 0.7% in the first week of November to within touching distance of an 14-week high as markets focused on the prospect of the US cancelling tariffs on $156bn of Chinese imports planned for 15th December and removing the 15% tariff it imposed on 1st September on about $125bn of Chinese imports.

It is notable that this modest rally was similar in magnitude to the up-tick in the Renminbi following President Trump’s announcement on 1st December 2018 that the US would delay a planned increase in tariffs on $200bn of Chinese imports to 25% from 10%.

However, the lack of tangible progress in US-China trade negotiations in the past week has seen the Renminbi NEER flat-line – as it did in the weeks following the US announcement on tariffs in early December 2018.

History suggests that if US-China trade negotiations stall in coming weeks the Renminbi NEER will continue to tread water, with a growing risk of it depreciating as the 15th December deadline approaches – a risk exacerbated by signs that Chinese economic growth remained weak in October by historical standards.

 

As forecast Renminbi weakened further this summer to 5-year low in late-August

We noted in “Renminbi depreciation true to form” (6 June 2019) that history was repeating itself, with the Renminbi Nominal Effective Exchange Rate (NEER) having weakened in April-June as it had done in May-July 2018, albeit at a more modest pace (see figure 1). This was a clear indication in our view that “Chinese policy-makers were once again using Renminbi depreciation as both a weapon in the trade war with the US and a tool to reflate the Chinese economy”.

 

Renminbi sticking to well trodden path 4

 

Moreover, we argued that unless the US and China quelled their trade war and/or Chinese economic growth rebounded, the risk near-term was that the Renminbi would weaken further. Indeed between 6 June and late-August, the Renminbi NEER weakened 2.7% to a five-year low – a similar pace of depreciation as recorded between mid-July and mid-October 2018 (see Figures 1 & 2).

 

Renminbi sticking to well trodden path 5

 

The Renminbi NEER was then broadly range-bound between late-August and early-October before making incremental gains in the second week of October on news of a thawing in US-China relations and progress made in negotiations in “Phase 1” of a bilateral trade agreement. Specifically US President Trump agreed to freeze a planned increase in tariffs on $250bn of imports from China. In exchange Chinese policy-makers agreed to significantly increase imports of US agricultural products to about $40-50bn per annum and remove some restrictions on US agricultural imports, although details on timelines and implementation have remained vague.

The Renminbi NEER then remained broadly unchanged in the second half of October before appreciating about 0.7% in the first week of November to within touching distance of an 14-week high, according to our estimates.

This rally coincided with reports that the US and China were discussing an agreement which would see the US drop its plan to impose on 15th December tariffs on the remainder of Chinese imports (about $156bn) and remove the 15% tariff it imposed on 1st September on about $125bn of Chinese imports – which would effectively leave tariffs on only the original $250bn of imports. As figure 1 shows, the magnitude of this up-tick in the Renminbi NEER was similar to that of the rally following the President Trump’s announcement on 1st December that the US would delay a planned increase in tariffs on $200bn of Chinese imports to 25% from 10%.

 

Recent Renminbi rally has stalled as markets awaits progress in trade negotiations

However, the lack of tangible progress in US-China trade negotiations in the past week has seen the Renminbi NEER flat-line – as it did in the weeks following the US announcement on tariffs in early December 2018 (see Figure 3). History suggests that should the US and China fail to announce a material breakthrough in negotiations in coming weeks the Renminbi NEER will continue to tread water, with a growing risk of the Renminbi NEER weakening as the 15th December deadline approaches (see Figure 1).

Should the US impose tariffs on a further $156bn of Chinese imports on 15th December, signs that Chinese economic growth remained historically weak in Q4 would exacerbate the underlying risk of the PBoC forcefully weakening the Renminbi by fixing USD/CNY higher or at least allowing the Renminbi to weaken, in our view. Official and Caixin PMIs for the manufacturing and service sectors weakened in aggregate in October, particularly when residual monthly seasonal patterns are factored in, pointing to a risk that Chinese GDP growth, which slowed to 6.0% year-on-year in Q3, slowed slightly further in Q4.

 

Renminbi sticking to well trodden path 6

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