China: Can the new RMB fix, fix the problem? – Deutsche Bank

Analysts at Deutsche Bank explain that the change in the RMB fixing mechanism, the ongoing downside bias on the USD/CNY fix, and possible USD selling by the PBoC has resulted in strong RMB appreciation in both the onshore and offshore markets recently (1.44% appreciation of the CNY and 2.27% appreciation of the CNH vs. the USD).

Key Quotes

“This has been one of the biggest moves in the China FX market since early this year, when authorities reportedly sold dollars offshore to wash out long USD/CNH positions.”

“Why now? According to CFETS, one of the reasons for introducing a countercyclical adjustment factor is that the RMB has not been performing in line with the broader dollar's performance and China's improved economic position. In their view, the onshore FX market has been susceptible to “irrational expectations” that have exaggerated one-sided FX moves. Hence, the introduction of a “countercyclical” factor into the fixing formula was necessary to offset the “herd effect” and make the USD/CNY fix more reflective of genuine demand and supply in the market and economic fundamentals.

The other reason for this change could be the authorities’ desire to gain back some control over the fixing.”

“Does China really want a significantly stronger RMB? In our view, China does not want significant appreciation in the RMB. Why? First and foremost, the CNY, by our estimates, was overvalued by an average of ~8% across BEER, FEER and productivity-adjusted PPP frameworks before the recent moves. Second, the ongoing RMB appreciation could have an impact on China’s external sector. According to an NBER paper a few years ago, a 10% CNY appreciation against its REER would lead to a 13-19% reduction in exports. Given that ordinary goods account for the largest share in total exports (57%), a sizeable appreciation should have an impact.”

“What is the possible size of inflows if USD/CNY continues to be fixed lower? In our view, the flows most vulnerable to ongoing RMB appreciation at this juncture are: (1) the stock of overseas bonds with banks ($150bn); and (2) overseas FX deposits ($382bn), for a total of $532bn. In addition, we could see the unwinding of FX deposits in the onshore market, totalling about $780bn – corporates: $459bn, households: $125bn, and others: $194bn. In the offshore market, ongoing CNH appreciation could result in: 1) unwinding of some long USD/CNH positions, and (2) incentivizing the market to sell USD/CNH in the near-term to pick up carry (4-7% annualized yield pick-up, at the time of writing).This would clearly result in significant appreciation of the RMB, particularly if the PBoC were to not intervene to buy USDs.”