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December 8, 2020

Far more to Renminbi than USD/CNY cross

BY Olivier Desbarres

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( 10 mins)

The prevailing market view, as depicted in a recent Reuters article, is seemingly that Chinese policy makers are happy to allow further Renminbi appreciation versus the Dollar driven by a rising domestic trade surplus and strong capital account inflows.

The Renminbi has indeed appreciated 2.2% versus the Dollar since our last report on 22nd October (PBoC likely to keep Renminbi on tight leash), with the USD/CNY cross currently trading near its lowest level since mid-2018.

However, the US accounts for only about 20% of Chinese trade in goods. The Renminbi Nominal Effective Exchange Rate is thus a far more accurate measure of overall Chinese export competitiveness and of the currency’s potential (dis)inflationary impact.

The Renminbi NEER slowly appreciated further in the run-up to the US elections on 3rd November but has since then depreciated about 0.9%, with the Renminbi underperforming many major currencies including the Euro and Korean Won. The Renminbi NEER is currently trading at the same level as it was on 22nd October, in line with our forecast that “near-term the PBoC is more likely in a first instance to slow the pace of Renminbi appreciation and ultimately arrest the currency’s climb”.

The Renminbi has weakened recently despite evidence of strong balance of payments inflows, including a record trade surplus of $74.4bn in November and a 11.8% yoy increase in FDI inflows, and data pointing to seasonal Renminbi strength in the month of November.

Price action in the past seven weeks suggests to us that the People’s Bank of China has been fixing the daily USD/CNY central parity rate slightly higher than implied by underlying market forces, allowing modest Renminbi NEER depreciation mainly to put a floor under Chinese consumer prices flirting with deflation (a view we expressed on 22nd October).

Near-term we expect the Renminbi to continue appreciating versus a slowly depreciating Dollar (Emerging Market currencies: Hopes and Realities, 2nd December 2020). However, we think the risk is tilted towards the PBoC further weakening the Renminbi NEER in coming weeks to the levels which prevailed in early September.

 

Renminbi has appreciated versus Dollar but more importantly depreciated in NEER terms

The prevailing market view is seemingly that Chinese policy makers are happy to allow the Renminbi to continue appreciating versus the Dollar because the rising domestic trade surplus and strong capital account inflows are driving the currency’s appreciation. That at least is the conclusion seemingly reached by Reuters in an article published on 4th December 2020. We think a more accurate interpretation is that Chinese policy-makers have stalled the more relevant Renminbi Nominal Effective Exchange Rate (NEER), in line with our expectations, despite strong balance of payments inflows.

 

Far more to Renminbi than USD/CNY cross 1

 

The Renminbi has appreciated about 2.2% versus the US Dollar since our last report on 22nd October (see PBoC likely to keep Renminbi on tight leash), as depicted in Figures 1 and 3, with the USD/CNY cross currently trading near its lowest level since mid-2018. However, the US accounts for only about 20% of Chinese trade in goods. The Renminbi NEER, a trade-weighted index of the Renminbi versus the currencies of China’s main trading partners, is thus a far more accurate measure than the USD/CNY cross of overall Chinese export competitiveness and of the currency’s potential impact on Chinese imported inflation. It is not without reason that in December 2015 the China Foreign Exchange Trade System (CFETS), a sub-institutional organization of the People’s Bank of China (PBoC), introduced a new exchange rate index which values the Renminbi against a trade-weighted basket of 13 currencies.

 

Far more to Renminbi than USD/CNY cross 2

 

The more relevant Renminbi NEER appreciated further in the run-up to the US elections on 3rd November and hit a 136-week high on 4th November. However, it has since then depreciated about 0.9%, according to our calculations, and remains within its very narrow seven-week range of only 1.2% (see Figures 1-3). The Renminbi NEER is currently trading at the same level as it was on 22nd October.

This price action is in line with our forecast that “near-term the PBoC is more likely in a first instance to slow the pace of Renminbi appreciation and ultimately arrest the currency’s climb” (see PBoC likely to keep Renminbi on tight leash, 22nd October 2020). The Renminbi has appreciated only modestly against a weakening US Dollar (see Figures 2 & 3), only marginally outperformed the currencies of a number of China’s main trading partners, including the Taiwan Dollar, and underperformed the likes of the Euro and Korean Won (see Figure 3).

 

Far more to Renminbi than USD/CNY cross 3

 

As a result the monthly pace of NEER appreciation slowed from about 1.8% in the four weeks to 22nd October to about 1.1% in the four weeks to 16th November before turning negative in early December (see Figure 4). Again this is in line with our prediction that “[a broadly stable Renminbi NEER] would translate into slower month-on-month appreciation, which would in turn be commensurate with the historical pattern of a reasonably rapid pace of appreciation preceding slower appreciation and eventually month-on-month depreciation”.

 

Far more to Renminbi than USD/CNY cross 4

 

Tepid Renminbi performance in past seven weeks despite strong FX inflows into China

Importantly, the Renminbi NEER has weakened slightly since 4th November despite evidence of strong balance of payments inflows and historical data pointing to seasonal Renminbi strength in the month of November. The Chinese goods trade surplus, not seasonally-adjusted, hit an all-time high of $74.4bn, while the three-month rolling surplus of $171bn was one of the largest on record. Figure 5 suggests that all things being equal this should have led to further Renminbi NEER appreciation. Moreover, the strength of China’s trade balance has been underpinned by the ongoing surge in exports, which were up 14.1% year-on-year in November and hit an all-time high of $268.1bn rather than a collapse in imports which were up 4.5% yoy in October-November (see Figure 6).

 

Far more to Renminbi than USD/CNY cross 5

 

Far more to Renminbi than USD/CNY cross 6

 

At the same time Foreign Direct Investment (FDI) inflows into China remained strong in November, with their USD-value rising 11.8% yoy (see Figure 7).

 

Far more to Renminbi than USD/CNY cross 7

 

Finally, monthly average NEER data for the past decade suggest that the Renminbi underperformed slightly in November 2020. Since 2010, the Renminbi NEER has on average appreciated by over 0.8% in the month of November, by far its strongest month of the year according to our calculations and more than one standard deviation from the monthly average gain of about +0.15% (see Figure 8). In comparison, the (average) Renminbi NEER in November 2020 was up only 0.7% over the (average) NEER in October 2020.

 

Far more to Renminbi than USD/CNY cross 8

 

PBoC seemingly leaning against Renminbi to minimise deflationary pressures

One possible explanation for the Renminbi’s rather tepid performance in the past seven weeks is that speculative and portfolio inflows into China, attracted by the country’s rapid economic recovery and higher bond returns, have slowed materially and potentially turned to outflows. Daily or weekly capital account flow data are at best patchy but in any case we think this is an unlikely explanation. A recent Reuters poll found that on average analysts expected China’s GDP to rise about 2% this year, the only major economy forecasted to record positive growth in 2020.

A more plausible explanation, in our view, is that the PBoC has fixed USD/CNY to keep the Renminbi on a tight leash, in order to protect domestic exports’ competitiveness and more importantly minimise deflationary pressures. The PBoC fixed the daily USD/CNY central parity rate, around which USD/CNY spot can trade 2% either side, at 6.532 on 8th December, about 1.9% lower than on 22nd October according to our calculations. Since then Renminbi (spot) has weakened about 2.2% versus the Dollar while the Renminbi NEER has been broadly unchanged as noted above (see Figure 9).

In the past 28 trading sessions USD/CNY has closed higher than the daily central parity rate (i.e. Renminbi weak versus fixing) only seven times. Put differently Renminbi spot has closed stronger versus the daily fixing three quarters of the time.

 

Far more to Renminbi than USD/CNY cross 9

 

This suggests to us that the PBoC has been fixing the Renminbi slightly weaker than implied by underlying market forces, mainly in a bid to put a floor under very low CPI-inflation. We had already argued on 22nd October that while “the case for the PBoC to weaken the Renminbi is not particularly compelling at this juncture given the underlying strength of the domestic economy and export sector […] the PBoC cannot ignore the deflationary impact of the Renminbi NEER’s appreciation. We think that near-term the PBoC will opt to keep the Renminbi NEER broadly stable” (see PBoC likely to keep Renminbi on tight leash).

Since then data released by the National Bureau of Statistics of China showed that headline CPI-inflation fell sharply in October to just 0.5% year-on-year, its lowest level in eleven years. Core CPI-inflation, which excludes more volatile food and fuel prices, remained at 0.5% yoy, its lowest level since March 2010, for the fourth consecutive month (see Figure 10). The Renminbi NEER’s 5.9% depreciation in July-October has arguably contributed to weak imported inflation and in turn to the 2.2 percentage point fall in headline CPI-inflation over that timeframe, even allowing for the transmission lag between the currency’s appreciation and consumer prices. We think that policy-makers will want to avoid consumer price deflation and the possible ensuing hit to business and consumer confidence.

 

Far more to Renminbi than USD/CNY cross 10

 

Near-term, we expect the US Dollar to continue slowly depreciating (see Emerging Market currencies: Hopes and Realities, 2nd December 2020) and for the Renminbi to continue appreciating versus the US Dollar. Indeed we think that sources close to the PBoC recently quoted as saying that the central bank did not see any need to intervene against Renminbi appreciation driven by strong fundamentals, including a current account surplus, were referring (implicitly) to the USD/CNY exchange rate.

However, we think the PBoC will at the very least try to keep the Renminbi NEER broadly stable in coming weeks, with the risk tilted towards the central bank weakening the Renminbi NEER by a couple of percent to the levels which prevailed in early September. This would translate, according to our estimates, to the pace of month-on-month depreciation accelerating towards around 2% in coming weeks, which would still not be extreme by historical standards (see Figure 4).

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