Leadership of the USD sell-off shifted to CNY from EUR recently. CNY gained on bunched-up equity inflows and expectations of stronger CNY to curb imported inflation while the European Central Bank’s push-back against taper talk slowed EUR appreciation. USDCNY broke below 6.40 after hovering between 6.40-6.60 for most of this year.
USDCNY broke below 6.40 after hovering between 6.40-6.60 for most of this year
Source: Bloomberg, Bank of Singapore
CNY strength is supported by fundamentals, which range from sustained strength in China’s export performance to pick-up in inflows to the onshore financial markets in 2Q21 while outflows – especially tourism – remain constrained. FTSE Russell’s bond index inclusion starting from October this year will see ongoing foreign bond inflows. In addition, CNY’s short-end yields are still superior amongst the major currencies.
There is some scope for improved US-China trade relations, including the potential for reduced tariffs. The first official meeting between US Trade Representative Katherine Tai and her Chinese counterpart Liu He concluded with an agreement for continued dialogue. This is a more constructive outcome than some investors feared after the last high-level engagement in Alaska. Prospects of tariff rollback would be positive for the CNY although progress on US-China trade talks look likely to be slow.
Short-end yield remain supportive for the CNY
Source: Bloomberg, Bank of Singapore
We see scope for continued gradual appreciation of the CNY towards our 12-month target of 6.15 against the USD.
However, a rapid appreciation of the currency is unlikely to be welcomed by the authorities. Amid growing market enthusiasm on recent CNY strength, the authorities have reiterated the current CNY policy, aiming to stabilise near-term market expectations. We see little reason for the Peoples’ Bank of China (PBoC) to deliberately seek CNY appreciation to curb rising import costs, since the recent surge in commodity prices largely came from the rest of the world, rather than due to China’s demand.
The verbal warnings against rapid CNY appreciation have escalated into action. The PBoC is leaning against this move by fixing USDCNY higher than expectations. The PBoC also announced that it will adjust the FX deposit reserve requirement ratio (RRR) from 5% to 7%, effective 15 June. This move may discourage excessive FX inflows and reduce appreciation pressures on the CNY, given the strong demand for converting FX to CNY currently amid the rapid CNY appreciation. This is the first change of this nature since 2007 and the announcement signals that there are enough tools in the central bank’s toolbox to curb rapid CNY appreciation without resorting to direct FX intervention. Moderate selling in the CNY followed the hike in onshore banks’ FX deposit RRR, but it was very minor against the broader backdrop of the rally this year.Disclaimer applicable to recommendation
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