The RMB has outperformed all its Asian peers so far this year, helped by a combination of reduced trade tensions and more optimism over China’s growth due to policy stimulus (Click here).
Following the indefinite delay of tariff hikes on China slated for 2 March, as well as positive signals from the White House, the US and China appear more likely to reach some type of agreement on trade later this month to include a rollback of some US tariffs on China at a tentative Trump-Xi ‘signing summit’. Growing expectations that a RMB stability clause will be part of the US-China trade deal has raised some market expectations of potentially significant currency appreciation.
Newswires reported the US is asking for a commitment to currency stability from China in trade talks although details are lacking. A wide-ranging Plaza-style accord to revalue the RMB is unlikely, as the 1985 G5 agreement is seen by some in China as a policy mistake by Tokyo that led to a major appreciation of the JPY and Japan’s resulting boom, bust and lost decades.
China, however, may be open to a commitment not to competitively devalue RMB to offset tariffs and gain trade advantage, which would be consistent with the existing FX policy goals of both the US and China. This reduces the risk of USDCNY climbing above 7 even if China’s growth slows further in the near-term.
Clues to the currency pact may be gleaned from the recent US-Mexico-Canada Agreement (USMCA) and revision to US-Korea Free Trade Agreement (KORUS) and may include increased transparency on intervention and provision of data. The overall take-away from US-China trade talks is expected to lean RMB positive.
RMB should also gain from potential portfolio inflows spurred by equity/bond index inclusion process. The recent MSCI rebalancing announcement with more China A-share weight is supportive of the RMB. We also see scope for an acceleration of inflows, driven by the inclusion of RMB assets in global bond funds.
However, there are limits to the extent of RMB appreciation. The shift in China’s current account from persistent surplus to about balance and the peak in China’s global goods export share suggest that the RMB is no longer undervalued. Policymakers are unlikely to want to tolerate overvaluation. In addition, any deal to cut America’s USD419bn trade deficit with China will likely add to concerns that China’s declining current account surplus would flip into deficit over the medium-term.
CNY is biased towards a slight appreciation, but scope for extended rally is limited
RMB also lacks the appeal of high real yield and interest rate spreads to the US are near record lows. Better to own IDR, RUB or BRL for yield. It is possible that Chinese policymakers will use the breathing space afforded by a trade deal to ease monetary policy – in order to mitigate the effects of returning capital inflows, any knee-jerk RMB reaction and a dovish Fed shift. This should limit the upside in RMB, even though it still leaves room for small moves. We are reflecting the limits to the extent of likely USDCNY downside with only a modestly lower 12-month USDCNY forecast of 6.60 (from 6.80 previously).
Being the regional currency anchor, with RMB likely to resist depreciation pressures, this should lend an additional layer of support for other Asian currencies. However, limits to RMB strength suggest that additional help in the form of a stronger EUR is crucial in bringing about a meaningful turn lower in the broad USD. EUR awaits a growth rebound in Europe to rally and we expect a European growth pickup to materialise to result in a weaker USD by late 2019.
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