Source: Finance Mayflower
Text: Kang Kai
At the end of the year and the beginning of the year, the renminbi once again accumulated rebound momentum.
On the last official trading day of 2023, the onshore and offshore RMB exchange rates both rose above the 7.1 yuan mark, hitting a new high since June 2023. The central parity of the renminbi also rose sharply to a seven-month high. From the beginning of November to the end of December 2023, the RMB appreciated by nearly 3% against the US dollar.
"In the last two months of 2023, I have earned almost the entire range of RMB appreciation. It is important to look at the direction and timing of the Fed's interest rate cuts. Linda, a forex trader based in Shanghai, said, "I'm still lucky that I didn't have a full holiday this Christmas holiday, so it was easier to seize the opportunity of the market rally." ”
Looking back at 2023, the RMB exchange rate has been under pressure for most of the time, repeating the ups and downs of 2022. For the whole year of 2023, the RMB exchange rate against the US dollar will fall by 2.89% annually, marking two consecutive years of decline.
In 2023, from April to June, the onshore and offshore RMB exchange rates will depreciate by 5.4% and 5.7% respectively. On May 19, the central parity of the RMB exchange rate against the US dollar broke 7 for the first time this year. On 8 September, the onshore renminbi hit 7.3510 against the US dollar, the lowest since late December 2007. On 25 September, the onshore RMB market deviated from the midpoint by -1.96%, the largest since October 2022. The next day, the onshore USD/CNY long-end swap fell below -2700 intraday, the lowest since June 2008. The offshore market is showing a similar and more pronounced depreciation trend.
Some traders have fresh memories of the September 2023 perception. "On September 8, when I first entered the trading room, I noticed that the RMB exchange rate had fallen sharply. At lunchtime in Central, there was a steady stream of people discussing exchange rates. Fortunately, I don't have too many long positions in RMB, otherwise it would have been a stormy 'Black Friday'. Leo, a foreign exchange trader based in Hong Kong, said.
At that time, tensions were also spreading in the onshore market. "The RMB exchange rate has hit a low point for a few days, and it is obvious that foreign trade customers can feel the anxiety, and they always come to ask whether to do hedging. Linda recalled, "In September, the renminbi exchange rate had been falling for some time. I wasn't sure if the market would reverse later, whether it would be long or short, after all, trading opportunities come from volatility and poor expectations. ”
The main market analysis believes that the divergence of the monetary cycle between China and the United States will continue to invert the interest rate gap between China and the United States, which is the main reason for the decline of the RMB exchange rate in 2023. In mid-to-late October 2023, the inversion of interest rate differentials between China and the United States peaked at more than 220 basis points.
However, with the Fed's dovish signals, the market generally believes that the inflection point of global market liquidity is approaching. Against this backdrop, the inversion of interest rate differentials between China and the United States narrowed by nearly 100 basis points in the last two months of 2023, and many investment banks raised their RMB exchange rate forecasts at the end of the year.
UBS believes that by the end of 2024, the RMB exchange rate against the US dollar may rise to 7.0, compared with the previous forecast of 7.15. Goldman Sachs said that in the next six months, the yuan may rise to 7.10 against the US dollar, and 12 months later it may rise to 7.05. According to the latest Bloomberg survey, the median forecast for the renminbi against the US dollar will trade at 7.10 on the weak side in the first and second quarters of 2024, and then gradually rise, and is expected to rise above 7 by the end of 2024.
Guan Tao, global chief economist of Bank of China Securities, believes that the impact of cross-border capital flows and carry transactions on the RMB exchange rate is gradually rising. Under normal circumstances, exchange rate changes are the result of cross-border capital flows. In addition, from the beginning of 2023 to the end of August, interest rate differentials will have a greater impact on the RMB exchange rate. Basically, as long as the interest rate differential between the United States and China widens, the exchange rate of the renminbi will fall against the dollar.
"The economy is stable, the financial sector is stable, the economy is strong, the currency is strong. Overall, with the stabilization of economic fundamentals and the expected improvement of the financial market, the operation of the foreign exchange market is expected to continue to improve, and there is a good foundation for the RMB exchange rate to stabilize, and there are conditions to maintain basic stability at a reasonable and balanced level. He further said.
Zhang Ming, deputy director of the Institute of Finance and Economics of the Chinese Academy of Social Sciences and deputy director of the National Finance and Development Laboratory, said that looking ahead, the Fed's interest rate hike cycle will come to an end, the long-term interest rate in the United States and the dollar index will peak, and the external pressure on the RMB exchange rate will be reduced. From the perspective of China's economic fundamentals, China's high-frequency macro data is gradually rebounding. The Chinese government announced the issuance of 1 trillion yuan of government bonds, which helped boost China's economic growth. In the future, it is also necessary to pay attention to whether the liquidity crisis of China's private real estate developers has been fundamentally alleviated.
The renminbi exchange rate has fallen for two consecutive years
Judging from the trend of the whole year of 2023, the closing price of the RMB against the US dollar depreciated by 2.89% during the year.
In terms of stages, in 2023, the trend of the spot exchange rate of RMB against the US dollar will be mainly divided into four stages. At the beginning of the year, the market expected China's economic recovery to be imminent, and the renminbi briefly rose above 6.9. From the beginning of April to the end of June, the renminbi began to depreciate. During this period, the renminbi depreciated by about 5.4% against the US dollar at the close. At the beginning of August, this market intensified further. From early August to early November, the renminbi depreciated by about 2.1% against the US dollar at the close, and fell below the 7.3 mark for many days, hitting a new low since the end of December 2007. From the beginning of November to the end of December, the renminbi appreciated by nearly 3% against the US dollar.
However, from another indicator to measure the RMB exchange rate, the RMB/CFETS currency basket exchange rate index was 98.67 at the end of 2022 and 99.69 on October 20, 2023. This means that other non-US currencies depreciate more against the US dollar, and the renminbi appreciates against non-US currencies.
Zou Lan, director of the Monetary Policy Department of the People's Bank of China, said that the exchange rate of the RMB against the US dollar is very important, but it is not the whole of the RMB exchange rate, and we should pay more attention to the changes in the exchange rate of the RMB against a basket of currencies.
Zhang Ming believes that in 2023, the reason for the depreciation of the RMB against the US dollar is that the Federal Reserve tightens monetary policy, the US long-term interest rate rises and the US dollar index appreciates. The rise in long-term interest rates in the United States, the widening of the long-term interest rate gap between China and the United States, and the intensification of short-term capital outflows in China have exacerbated the depreciation pressure on the renminbi against the US dollar. In addition, in 2023, the US stock market index rose, the Chinese stock market index fell, and domestic and foreign investors reduced their holdings of Chinese stocks and increased their holdings of US stocks, which also exacerbated the pressure on China's short-term capital outflows, putting pressure on the RMB against the US dollar.
As of December 2023, the Fed's benchmark interest rate is in the 5.25%-5.5% range, the highest level since 2001. In mid-to-late October 2023, the interest rate on China's 10-year government bonds was more than 220 basis points lower than that of U.S. bonds of the same maturity, the largest since 2002.
According to data from the Hong Kong Stock Exchange, from August 7 to October 19, 2023, foreign investors had a cumulative outflow of US$22.1 billion in the A-share market, the largest outflow in the same period. According to data from the People's Bank of China (hereinafter referred to as the "People's Bank of China"), foreign currency deposits and loans decreased by US$75 billion and US$55.9 billion respectively in the first three quarters.
Zhang Ming also said that from the perspective of China's balance of payments, the surplus of trade in goods has decreased significantly compared with 2022, and there has been a large-scale deficit in the non-reserve financial account, and there has also been an outflow of errors and omissions of a certain scale. This means that the dynamic changes in the structure of the balance of payments have also brought certain depreciation pressure on the exchange rate of the RMB against the US dollar.
According to data from the State Administration of Foreign Exchange, foreign-related receipts and payments recorded a deficit of US$53.9 billion in September 2023, the largest since late 2015. Outflows were mainly in the capital and financial accounts, which recorded a deficit of US$45.3 billion. In terms of sub-items, the deficit in receipts and payments of direct investment in September was US$26.2 billion, the highest level since January 2016, and there has been a net outflow of funds for 15 consecutive months. Under securities, the deficit rose to nearly US$14.6 billion in September. However, in October and November, the situation narrowed.
Against this backdrop, the size of the onshore USD pool has declined. According to Xing Zhaopeng, senior China strategist at ANZ Bank, if the changes in the US dollar capital pool are constructed with an increase in foreign exchange settlement and sales funds, an increase in foreign exchange deposits, and a decrease in foreign exchange loans, from February 2023, China's domestic dollar pool will show a net outflow every month, with the highest net outflow of US$25.2 billion in August.
At the same time, the US dollar interest rate, which measures the price of the domestic US dollar, is getting higher and higher. At the end of June 2023, the weighted transaction rates of domestic interbank US dollar lending of all maturities rose above 5%, a new high since 2019. At that time, the average interest rate of the overnight dollar call weighted transaction rate of the overnight maturity interbank loan exceeded 22 basis points compared with the offshore US dollar guaranteed overnight financing rate (SOFR), the largest since the second quarter of 2020.
Market participants generally believe that in 2023, China's economic recovery will be less than expected, which is also a major reason for the decline of the RMB exchange rate against the US dollar. "The transfer of the supply chain may affect equity investment projects under direct investment (FDI). The restructuring of the real estate sector, the slow recovery of China's economy, and the rise of geopolitical risks are the main factors affecting equity investment and foreign confidence in China's capital market. Xing Zhaopeng said.
China's central bank maintained a stable exchange rate
In order to stabilize the exchange rate, the People's Bank of China (PBOC) has been releasing US dollar liquidity in the onshore market and RMB liquidity in the offshore market. This can reduce the cost of onshore US dollar financing and increase the cost of offshore shorting of RMB.
Specifically, in the onshore market, the People's Bank of China (PBOC) raised the macro-prudential adjustment parameters for cross-border financing and lowered the foreign exchange reserve ratio. At the same time, China's central bank measures also include lowering the upper limit of the US dollar deposit rate, guiding large banks to sell US dollars, and window guidance to set a stronger median price. In the offshore market, the People's Bank of China (PBOC) issued offshore central bills, creating a high-interest rate environment for the offshore renminbi. At the same time, fiscal policy has also stepped in, and China's Ministry of Finance has repeatedly issued offshore government bonds in Hong Kong, China.
According to the U.S. Treasury Department, Chinese investors sold nearly $15 billion in long-term U.S. Treasury bonds and more than $5 billion in U.S. equities in August 2023, a four-year high. Market participants believe that this may be to obtain US dollar cash in case of defending the RMB exchange rate in the future.
"Every time the renminbi exchange rate falls to around 7.3, the market's nerves are tense. Everyone is speculating about where the bottom line of the market is, and at this time, everyone does not dare to act rashly, and the market liquidity is reduced. At this time, the central bank intervenes in the market, and the effect will be significant. Linda said.
Under the regulatory sniping, the RMB bears gradually dissipated. At the beginning of September 2023, the 1-month risk of CNH reversed to -0.1725, a new low since the beginning of 2019, and the negative range of this indicator means that the options market is more bullish on RMB. Onshore USD liquidity also rose.
As of October 20, 2023, the spread between the weighted average rate of overnight interbank US dollar calls and the offshore US dollar guaranteed overnight financing rate (SOFR) has fallen to its lowest level since late April 2023.
Yuan Tao, chief macro foreign exchange analyst of the Orient Futures Derivatives Research Institute, said that the intervention of the People's Bank of China in the exchange rate market has always been counter-cyclical. When the dollar strengthens, the renminbi will not be allowed to depreciate along with other non-US currencies, because this will create a competitive depreciation risk with other currencies.
Wang Ju, head of foreign exchange and interest rate strategy for Greater China at BNP Paribas, said that in 2023, the background of the depreciation of the yuan against the US dollar is: the Federal Reserve raises interest rates and the People's Bank of China still cuts interest rates. This means that China's central bank has previously tolerated a certain depreciation of the exchange rate. The reason for intervening in the RMB exchange rate against the US dollar now is to avoid the RMB exchange rate from the current point to depreciate and cause market panic, "the dislocation of the economic fundamentals and currency cycle between China and the United States has driven the resonance of China's stock, exchange rate and commodity markets, and a stable exchange rate can send a signal to the entire capital market to maintain stability."
She also said that China's economy is dominated by manufacturing and has a huge trade surplus, and it is qualified to use the trade surplus under the current account to stabilize the exchange rate and ease the pressure of capital outflows. In the face of the current capital outflows and local currency depreciation, smaller economies have to respond by passively raising interest rates.
Enthusiasm for RMB financing has risen
Foreign investors' enthusiasm for RMB loans and bonds is on the rise. In October 2023, the China Development Bank signed RMB-denominated loan contracts with the Central Bank of Egypt and other banks, and the Export-Import Bank of China signed a loan agreement with the Saudi National Bank in RMB.
Wind data shows that as of October 17, 122.5 billion yuan of panda bonds have been issued in 2023, an increase of 44.7 billion yuan year-on-year. According to data from Deutsche Bank, in the first nine months of 2023, the issuance of Chinese-funded offshore RMB bonds (including dim sum bonds and free trade zone bonds, excluding certificates of deposit) exceeded 21.6 billion yuan, three times the issuance in the same period of the previous year. According to data from the Hong Kong Monetary Authority, in the first eight months of 2023, the issuance of dim sum bonds in Hong Kong has exceeded that of 2022, reaching 343 billion yuan, a year-on-year increase of 62%.
Panda bonds are RMB-denominated bonds issued by foreign-funded enterprises and governments in China, while dim sum bonds are RMB-denominated bonds issued in offshore markets such as Hong Kong or London.
"The cost of RMB financing is relatively low, and now the actual borrowing rate of the RMB is only about 2.00 points, while the interest rate of the US benchmark has risen to more than 5.00 points. A person from a major state-owned bank said.
Samuel Fischer, head of China debt capital markets at Deutsche Bank, said that for panda bonds, the annualized yield of the US dollar can be estimated through swaps based on the yield of Chinese government bonds. At present, the yield of CDB bonds is basically flat when converted into US dollars, and there is a negative interest rate differential when converted into euros.
Some issuers can issue panda bonds onshore in China and then transfer the liabilities offshore to replace high-cost US dollar bonds. According to Deutsche Bank's calculations, if the RMB swap is exchanged for foreign currency, the issuer can save 20-100 basis points. Looking at other banks, the coupon rate of the three-year panda bond issued by ICBC (Macau) in April was 3.09%, which was about 140 basis points lower than the coupon of 4.5% of the US dollar bond of the same maturity issued by its Hong Kong branch in January.
In this context, the issuers of panda bonds and dim sum bonds are becoming more and more diversified. "The issuers of the panda bond market now include financial institutions, enterprises, multilateral institutions and sovereign governments, and national entities include red-chip enterprises (i.e. enterprises registered overseas and with their main business activities in China) and local investors in Hong Kong. Fang Zhongrui said.
Wang Lei, head of Deutsche Bank's China offshore debt capital market, said that in terms of dim sum bonds, since 2023, local institutions in Hong Kong, China, such as the Hong Kong SAR government, Swire Properties, and MTR MTR, have also entered the dim sum bond issuance market through public and private placements. Not only that, but the number of investors in Europe and the Middle East is also booming. Previously, the issuers in the dim sum bond market were mainly Chinese-funded institutions.
In Fang's view, the surge in RMB bond issuance will help promote the internationalization of RMB. "As multinational groups continue to expand their business in China and improve their localization, panda bonds will play an irreplaceable role in the financing process. As a financing tool for multinational enterprises, the use of RMB on the liability side will promote the overall use of RMB. He said.
Wang Lei said that in the past few years, the market has mainly issued dim sum bonds with a maturity of 2 to 5 years. At the beginning of 2023, the Hong Kong government issued a 10-year dim sum bond of 3 billion yuan, and the market enthusiasm is no less than that of short- and medium-term bonds. Against the backdrop of the increase in RMB trade settlement, the accumulation of RMB positions of overseas investors, and the continuous expansion of the number of market makers, the dim sum bond market is expected to complement the financing channels of the onshore market and enrich offshore RMB products.
However, Fang Zhongrui reminded that if the renminbi wants to become an international currency in the true sense, it must also have a comprehensive range of financial products. Most companies use the US dollar as the denominated currency because the US dollar can be used in multiple scenarios such as global trade settlement, balance management, and asset-side investment.
Zhang Ming believes that the objective reality that the international status of the renminbi lags behind China's economic status may exist for a long time in the future. To promote the internationalization of the RMB, it is necessary to combine the restructuring of the industrial chain, the settlement and valuation of bulk commodities, the high-level opening up of the financial sector, and the construction of financial infrastructure.
The U.S. dollar and China's economic trends
Looking forward to the trend of the RMB exchange rate, Yuan Tao expects that in 2024, the Federal Reserve's monetary policy may shift, and the RMB exchange rate may rebound to about 7, or even to about 6.8. Wang Ju said that the RMB exchange rate is expected to return to about 7 points in the future. Xing Zhaopeng believes that the RMB exchange rate against the US dollar may fluctuate in the range of 7.0-7.2 in the future.
From the perspective of the external environment, the trend of the US dollar will become the key to affecting the RMB exchange rate. This depends on the Fed's interest rate cut process, whether inflation will continue to cool, and whether the US economy will have a soft landing.
On December 13, 2023, the Federal Reserve's latest dot plot showed that for the first time since March 2021, Fed officials predicted no further rate hikes. Most Fed officials also expect the Fed to keep interest rates in a range of 4.5% to 4.75% by the end of 2024, equivalent to three 25 basis point rate cuts at current levels, for a total of 75 basis points.
Fed interest rate dot plot for December 2023 (Chart source: Fed)
The market's expectations are more aggressive. As of now, traders expect the Fed to cut rates by at least 150 basis points in 2024, with the first rate cut coming as early as March 2024. This is higher than the forecast of less than 100 basis points in mid-November 2023. Since the Federal Reserve's December 2023 meeting, speculative traders' USD positions have become increasingly bearish.
The reason why the market is betting on the Fed to cut interest rates sharply is because inflation in the United States continues to cool, suggesting that the Fed's anti-inflation journey is only "the last mile". The U.S. economy may show signs of downturn as the labor market cools.
In November 2023, the U.S. Consumer Price Index (CPI) rose 3.1% year-on-year, and only 1.4% after excluding housing prices. For the week ended December 23, 2023, the number of initial claims for unemployment benefits in the United States was 218,000, higher than the forecast of 210,000 and the previous value of 215,000.
From the perspective of the internal environment, China's monetary policy, real estate and foreign trade trends will become the key factors affecting the RMB exchange rate. If China's monetary policy continues to be accommodative, the narrowing trend of interest rate differentials between China and the United States may slow. The failure of the real estate sector to restructure will weaken foreign confidence in China's economy. If foreign trade stabilizes and improves, it will help promote the inflow of funds under the current account and hedge the risk of capital outflow under the capital account.
In terms of monetary policy, Xiong Yi, chief economist of Deutsche Bank China, said that the central bank of China is more restrained and hopes to keep the policy rate close to the natural interest rate. Under the condition that inflation expectations remain unchanged, it is appropriate for the PBOC to cut the medium-term lending facility (MLF) rate by a total of 40-50 basis points in the fourth quarter of 2023 and in 2024.
In terms of real estate, data from real estate professional monitoring agencies shows that in 2023, the transaction area of newly built commercial residential buildings in China's key 100 cities will decrease by about 6% year-on-year, the absolute scale will be the lowest level since 2016, and the land transaction area in China will be 1.28 billion square meters, down 20% year-on-year, and the total transaction volume will be 3.9 trillion yuan, down 17% year-on-year.
Lu Ting, chief economist at Nomura China, believes that the real estate sector is still in a state of deep contraction and is unlikely to return to previous levels. This is due to the decline in the number of young people in China, slower income growth and years of large-scale housing construction in urban areas. Some of the problems are structural rather than cyclical, such as the aging of the Chinese population, but this is an expected change over a long period of time.
J.P. Morgan Private Bank reports that the current core demand in the real estate market is about 800 million to 1 billion square meters per year, and the investment demand has almost completely disappeared. Of the 56 billion square metres of homes currently under construction, probably half are still up for sale. At the current rate of demand, it may take 3-4 years to digest the stock.
(At the request of the interviewee, "Leo" and "Linda" are pseudonyms.) This article was first published in Finance Yearbook: 2024 Forecast and Strategy, updated on January 3, 2024)