China avoided being labeled by the US Treasury as “currency manipulator” in its semiannual report on the macroeconomic and exchange rate policies of its major trading partners, but the CNY is not out of the woods yet.
The US Treasury report continued to reflect a US trade policy that is becoming increasingly targeted on China. Tougher language on China in the report suggests that the US Administration stands ready to increase pressure on China should discussions between President Trump and Xi not bear fruit at the G20 summit on 30 November-1 December.
An emerging worry is that a stable CNY anchor may be compromised. Much lower capital market inflows may further reduce support for the CNY given an already declining current account surplus.
CNY CFETS index broke 2017 low
Source: Bloomberg, Bank of Singapore
The absence of a particularly strong CNY fixing lately could suggest that the authorities do not see 7 as an important psychological threshold to defend anymore for USDCNY. The CNY China Foreign Exchange Trade System (CFETS) index has broken the 2017 low of 92. This may suggest more depreciation lies ahead versus the CFETS basket given further tariff threats.
USDCNH swap points have also eased from recent highs, indicating CNH liquidity conditions remain relatively benign and highlighting limited action to restrain CNH depreciation.
Worries over headwinds to growth from trade tariffs and weak asset markets have led to a pause in financial deleveraging, while fiscal pump-priming and liquidity injections were cranked up. Chinese policymakers appear to favor a stable CNY judging from regulatory changes (e.g. return of reserve requirements on FX positions in early August, however, a shift in policy goals to boost the domestic economy may be favored over maintaining the stability of the CNY in response to growth pressures from tariffs.
The CNY could slip past 7 against the USD but it seems unlikely that the market will wrest control over the CNY from the authorities. It is more likely for the authorities to impose a targeted capital control to limit outflow risks. In other words, the authorities are unlikely to lose control of CNY and the risk of CNY spiraling into a free fall remains low in our view.
While a weaker CNY could help offset the negative impact of tariffs on growth, the authorities are likely to be mindful that CNY depreciation could potentially be a double-edged sword, as it could fuel capital flight and antagonise the Trump administration further. Given the limits of weaker CNY in supporting growth, it is reassuring that the government has issued a draft plan for personal income tax cuts to spur consumption growth and a trio of Chinese regulators have spoken out in an effort to reassure markets that they will maintain stability.
EM high-yielders such as TRY, ZAR, BRL and RUB have rebounded over the past two weeks as crisis-hit countries such as Argentina and Turkey have started to walk the talk of policy tightening to reduce external imbalances. However, it will be hard for Asian currencies to follow when CNY, Asia’s currency anchor, remains under pressure.
We maintain the view that a weaker USD in 2019 from fading growth exceptionalism in the US, along with China’s growth stabilisation, which should be more evident in 4Q18, could ease pressure on the CNY over the medium-term.Disclaimer applicable to recommendation
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