The pressure on the renminbi to depreciate is huge, and the central bank is faced with a dilemma between increasing exports and weakening the dollar

Mars macroscopic

2024-06-11 01:27Posted in Hunan Finance and Economics Creator

Executive Summary:

The market pushed the renminbi weaker, and the central bank's exchange rate stabilization led to a rare year of significant declines in the central parity for a year. The huge pressure on the depreciation of the renminbi came from the sharp widening of US bond yields. The next trend of the renminbi may be quite different from the willingness of the central bank. The central bank faces a dilemma between devaluing the renminbi to boost exports or boosting the renminbi to weaken the dollar.

First, the market pushed the RMB to weaken, and the central bank's stabilization of the exchange rate led to a rare period of significantly lower than the market price for a year.

Since the beginning of this year, the renminbi has faced tremendous depreciation pressure. The CNY fell 2.1% against the USD in less than half a year from 7.0978 at the end of last year to 7.2475 on Friday, June 7.

The PBOC has maintained a strong renminbi policy since the second half of last year amid mounting market pressure on the weakening renminbi, keeping the renminbi's daily parity against the US dollar (the reference rate at which the renminbi is allowed to trade) in an unusually narrow range of 7.08 to 7.11. Last Friday's central parity of the renminbi was only 0.4 percent lower than at the end of last year, less than one-fifth of the market price decline.

As a result, the central parity has been consistently below the market price since July last year, and since April this year, the onshore yuan has traded at a discount of nearly 2% to the mid-parity, whereas the central parity of the renminbi has generally fluctuated around around 0.5% above and below the market price of the onshore renminbi for most of the history. It is very rare for the median price to be set at 1.9%-2% below the market price for more than two months. When the CNY fell below 7.31 against the USD in late October 2023, the duration of the midpoint parity, which was 1.9%-2% lower than the market parity, did not exceed 10 days. The huge spread between the mid-price and the market price, which lasted for more than two months, was the first time in eight years that trading data was available.

At the same time, the situation of mutual fluctuations between the onshore RMB exchange rate and the offshore RMB exchange rate has also been broken, and the offshore RMB exchange rate has been lower than the onshore exchange rate since the beginning of this year.

This means that there is increasing selling pressure on the RMB in the market, and the PBOC is under great pressure to depreciate the RMB.

Second, the huge pressure on the depreciation of the renminbi comes from the sharp widening of the yields of Chinese and US government bonds.

The market has driven the RMB weaker, and the direct reason is that since the beginning of this year, the yield of RMB government bonds has continued to fall, but the yield of US bonds has continued to rise. The gap between U.S. and Chinese Treasury yields continues to widen. The yield on the 10-year US Treasury rose to 4.43% on Friday, June 7 from 3.88% at the end of last year, while the yield on the 10-year Chinese government bond slipped to 2.28% on Friday from 2.56% at the end of last year. The gap between the yield of 10-year Treasury bonds between China and the United States widened to 2.15% from -1.32 percentage points at the end of last year. As we all know, capital always tends to go to markets with higher yields.

As a result of the significant downward pressure that has accumulated over the past few months, many traders are expecting a one-time depreciation of the yuan, similar to the situation in 2015.

In 2015, the PBOC suddenly devalued the renminbi, believing it to be overvalued. This has sparked turmoil in financial markets, including a sharp sell-off of the renminbi by global managers, severe capital outflows, and a 1 trillion yuan drop in the central bank's foreign exchange reserves as regulators intervened to sell foreign exchange to buy the renminbi in an attempt to calm the market.

The PBOC does not want to see the RMB exchange rate change rapidly, preferring to fluctuate steadily. The depreciation of the renminbi will also have a huge impact on global trade, potentially exacerbating US-China trade tensions by boosting the US-China trade surplus by improving the competitiveness of China's exports to the US.

In order to stabilize the exchange rate, since the beginning of this year, the central bank has repeatedly stressed that it "has the confidence, conditions and ability to basically stabilize the RMB exchange rate at a reasonable and balanced level" and will "resolutely prevent the risk of exchange rate overshoot".

The central bank said that the import and export data has improved this year, and "as a series of macro policies gradually take effect, China's economic recovery will be further consolidated and strengthened, supporting the RMB exchange rate".

But persistently high interest rates in Western economies, especially in the United States, have led to a sharp decline in the exchange rate of the renminbi and other Asian currencies against the dollar.

While the renminbi has depreciated by about 2.1 percent against the dollar this year, the yen has fallen more than 11 percent and the won has fallen more than 5 percent. The fact that the yen and the won have fallen more sharply is not because their balance-of-payments pressures are greater than ours, but because they are both freely convertible currencies, it is much more difficult for the central bank to control the exchange rate.

Third, there may be a big difference between the next trend of the renminbi and the willingness of the central bank.

This is because the U.S. economy is surprisingly good due to the strong labor market, labor wages are growing faster than inflation, and demand continues to be strong, resulting in inflation sticky above 3%, which has led to the Fed having to delay the start of the interest rate cut cycle.

However, the mainland is facing a situation where household purchasing power is insufficient, demand is weak, consumption is sluggish, there is oversupply, and the overall price increase has been negative for more than a decade, and the market needs the central bank to continue to cut interest rates. The central bank has repeatedly stated that it wants to keep interest rates low or cut them if necessary in response to the macroeconomic weakness in the wake of the housing market crisis.

This has led to a widening gap between US and US government bond yields, increased capital outflows, and RMB shorts still dominate the market.

In the medium term, while the Fed expects that it may start cutting rates later in the fourth quarter of this year, the shorter cycle of this rate cut will keep US Treasury yields above RMB yields for the foreseeable future.

In addition to the yield gap between China and the United States, potential trade disputes also have an impact on the RMB exchange rate. The market is increasingly worried that the United States has recently raised tariffs on a number of Chinese goods significantly, and the European Union is also investigating some of them, and there is a high probability that tariffs on these goods will also be increased in the near future, which may lead to a decrease in our commodity export revenues, a narrowing of the balance of payments surplus, and a downward pressure on the RMB exchange rate.

On Wednesday, Gita Gopinath, the first deputy managing director of the International Monetary Fund, urged the central bank to consider allowing more flexibility in the renminbi's exchange rate, saying it "would reduce the risk of deflation and help absorb external shocks."

However, despite the pressure on the market, the central bank has yet to issue any plans to change the course of its exchange rate.

At the same time, we are selling large amounts of long-term and ultra-long-term bonds to increase government investment in an attempt to boost economic growth, which could also put depreciation pressure on the RMB.

Although on the surface, the issuance of long-term bonds may provide a positive catalyst for the government to support the medium-term economy through more spending, which may provide a positive catalyst for supporting the currency. However, since the root cause of China's economic downturn is the lack of demand caused by the low proportion of labor remuneration in the national income distribution system, the more the government tends to invest in spending, the greater the pressure on oversupply, and the greater the resistance to the normal cycle of the economy from production to consumption, which will become the pressure of currency depreciation.

From a simple trade perspective, the yuan doesn't seem to be overvalued, as long as export growth has been strong, in which case the yuan usually rises against the dollar. However, on the one hand, there is less and less room for external demand to make up for domestic demand, and the trade protectionism of major economies such as Europe and the United States is also increasing, and the momentum for sustained export growth is also getting smaller and smaller, and the RMB usually falls against the US dollar.

Still, the central bank is also reluctant to let the yuan weaken against the dollar because it is a clear departure from its previous policy, under which the People's Bank of China tracks a basket of currencies.

But growing pressure on the market is also forcing the central bank to weigh how to release the market's pent-up pressure on the renminbi, for example by allowing the gradual weakening of the central parity of the renminbi. A slow reduction in the central parity of the renminbi can not only release pressure, but also avoid large fluctuations in the exchange rate.

Fourth, the central bank faces a dilemma between devaluing the renminbi to increase exports or boosting the renminbi to weaken the dollar.

There is no doubt that the world is entering a new period of monetary policy divergence after a period of synchronized action by most of the world's central banks, and although the ECB began to cut rates last week, it seems unlikely that the Fed will follow suit anytime soon, the Bank of Japan is more likely to raise rates, and the pressure on our central bank to continue cutting rates is increasing.

At the same time, the resurgence of protectionist and mercantilist trade policies has given a red light to our export-dependent economic policies and created risks for future currency wars.

And our central bank is in a dilemma.

On the one hand, we need to increase exports to consume the lack of domestic demand and promote economic growth, which requires the depreciation of the yuan to improve competitiveness against the yen and the won. Especially with the recent strengthening of the renminbi against other Asian currencies. This is the economic task of the central bank.

On the other hand, promoting the renminbi as a "strong currency" is also one of the tasks of the central bank as part of a plan to strengthen China's status as a financial powerhouse. A strong currency requires the renminbi exchange rate to rise, and the international demand for the renminbi increases, weakening the dominance of the dollar. This is the political task of the central bank.

There is naturally no third way between allowing the renminbi to depreciate and increasing exports and ensuring that the renminbi appreciates and constructing a strong currency. And how to choose is not easy.

[Author: Xu Sanlang]

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Personal opinion, for reference only