Keeping its value steady vs the dollar, the renminbi has become increasingly expensive against its other trading partners. Until recently, the Chinese renminbi has been steadily appreciating against the U.S. dollar. Figure 1 below shows that the US dollar (as represented by the DXY) has surged against most currencies since September 2021 when U.S. Treasury yields started rising sharply. The yield of two year treasury note rose from 0.2% in September all the way with almost unstopped to today’s 2.7%. The rise in US bond yields is a key driver for the strength of the US dollar. By keeping its exchange rate stable to the U.S. dollar, the renminbi has become increasingly expensive versus other currencies. Since September 2021, the renminbi has appreciated 16% versus the Japanese Yen (Figure 2), 8% versus Euro and 7% versus the Korean Won. With China’s economic growth is rapidly decelerating, the depreciating pressure on the renminbi is building. The drastic depreciation of the Japanese Yen, which accounts for 11% of renminbi’s reference basket, since March, intensified such pressure.
Capital outflows in 2022 have further heightened the pressure. As U.S. bond yields rising massively since September last year, the Chinese government bond yields from the 2-year tenor to the 20-year have become lower than those of the U.S. Treasuries (Figure 3). This has contributed to a decrease of RMB 165 billion in foreign holdings in Chinese domestic renminbi bonds in February and March 2022. It was the first time that foreigners were net sellers in Chinese domestic renminbi bonds for years. Outflows also happened in equities. The Hong Kong Connect data showed that a total of about RMB 100 billion flew out of mainland China in the form of either reversal of Northbound investments from Hong Kong into stocks listed in Shanghai or Shenzhen, or mainland investors’ Southbound investments into the Stock Exchange of Hong Kong.
Weaker economic growth and looser monetary policy. In our previous note, we discussed the significant likelihood of sharp deceleration in growth of the Chinese economy. Early this week, in its World Economic Outlook April 2022, the IMF lowered its forecast for China’s 2022 GDP growth to 4.4% YoY from 4.8% YoY. Financial market economists have also been revising down their China GDP forecasts. While the downward revision shown in Bloomberg’s survey has been relatively moderate to 5% YoY, quite a number of investment banks have revised down their China 2022 GDP forecasts to between 4% and 4.5%. Against a weakening economic backdrop in China, the divergence of monetary policies, with the U.S. tightening and China easing is not only going to persist but most probably to widen further.
The renminbi’s move lower against the dollar may persist. The Chinese economy’s weak outlook and this time includes its previously buoyant export sector, is likely to drag the renminbi lower in the coming months to partially close the gap of between the renminbi and the DXY. While we are expecting the gap between the DXY and the renminbi to narrow, we do not anticipate that it will be closed completely. With 70% of its oil consumption, 40% of its natural gas consumption and 20% of its grain (including soybeans) consumption are imported, China is motivated not to add to the bills that the country needs to pay for these materials in renminbi terms. Moreover, China also be mindful of not making its inflation picture worse by adding drastic currency depreciation to increasingly unfavorable terms of trade. We suspect that the stability of the renminbi was one of the key factors that the People’s Bank of China (PBoC) took into consideration when they decided not to fulfill the market’s expectation for rate cuts in April and to deliver a reserve requirement ratio cut for a magnitude below expectation.
In conclusion, we are expecting the renminbi to gradually depreciate against the dollar over the coming months but the pace will be measured.
Potential reversal of CNH/JPY strength. In our opinion, the wide valuation between the renminbi and the Japanese Yen is over stretched. While foreign exchange rate in Japan is the mandate of the Ministry of Finance, any meaningful reversal in USDJPY is probably depending more on the Bank of Japan’s (BoJ) yield curve control (YCC) policy. The BoJ is having its monetary policy meeting on April 27 and 28. Although the BoJ is widely expected not to change its YCC policy in this meeting, any hints in the Outlook for Economic Activity and Prices report or from Governor Kuroda’s remarks during the press conference mentioning concern about rising inflation may trigger unwinding of substantial amount of long USDJPY positions ahead of the Golden Week holiday starting from April 29. For investors who are inclined for such a scenario, shorting CNH/JPY may be something that they can consider.