Caixin View: Still No Need to Panic on Yuan
The yuan’s steep fall against the dollar since June 14 has been one of the big stories of the summer, prompting accusations from U.S. President Donald Trump that China has been manipulating its currency to boost its trade competitiveness. While we think this is very unlikely, as the risks of market panic and capital flight are far too high, the central bank’s tolerance for a weaker yuan is certainly greater than we’d predicted just a few weeks ago. The People’s Bank of China (PBOC) set the yuan’s daily reference rate against the dollar at 6.8131 on Monday, more than 6.5% lower than the 6.3962 set on June 14, when the weakening began.
However, we don’t think there’s much room left for the yuan to fall against the dollar in the short term, as two of the fundamental pressures on the currency are easing.
We see three main factors weighing on the yuan at the moment:
● The narrowing interest rate differential with the U.S. When the Federal Reserve last raised the cost of borrowing by a quarter of a percentage point on June 13, the PBOC declined to follow.
● A strong dollar. The Dollar Index, which measures the value of the greenback against a basket of currencies of U.S. trading partners, has risen by 0.55% since the start of June.
● U.S.-China trade tensions. There are no signs the two sides are planning to restart negotiations.
But only the last, least-predictable factor could continue putting strong pressure on the yuan in the short term. The other two are likely to ease, at least in the near future.
First, we think the dollar’s rise will tail off. The Dollar Index has been hovering around 94.6 for a week, having slipped back below the 95 level it reached earlier in July. In its annual External Sector Report issued last week, the International Monetary Fund said that the U.S. dollar is overvalued, while it considers China’s yuan to be in line with fundamentals. The Citi Economic Surprise Index for the U.S., which indicates how well economic data match up to the consensus forecasts of economists, slipped to a 10-month low last week, hitting -5.4 on July 25. A negative reading indicates that data releases are on balance not meeting the levels predicted. Trump has also expressed his desire for a weaker dollar to help boost U.S. exports.
Second, the yuan has now almost sunk to a level that basically reflects the interest rate differential with the U.S. — which we think is about 6.9 –– so further pressure caused by this factor will soon ease. The Fed is expected to raise rates again, especially given healthy growth figures — the U.S. economy grew at an annual rate of 4.1% in the second quarter, the highest since the second quarter of 2014, although it’s expected to slow by the end of the year. When the Fed last raised rates in June, it indicated another two increases were on the cards for the rest of the year, which means one in September and one in December. But we think that these two increases are already priced in and won’t have any impact on yuan/dollar movement.
Trade is the wild card here. The U.S. and EU held talks last week that yielded some progress in averting an all-out trade war and a pledge to lower tariffs: The U.S. said it will suspend further tariffs in return for the EU buying more American energy and soybeans. But we don’t think has any positive implications for China — White House economic adviser Larry Kudlow told Fox Business News after the deal was agreed that the “U.S. and EU will be allied in the fight against China, which has broken the world trading system.” There has been no public indication that negotiators from China and the U.S. are working on an agreement to lower bilateral trade tensions, and Trump said on July 20 he was ready to impose tariffs on all Chinese goods imported into America.
Clearly the last few weeks have shown China’s increased tolerance for a weaker yuan. But we still expect intervention from the PBOC if the currency gets too close to 7 to the dollar, a level not seen since the first half of 2008. We could also see even stricter capital controls – steep slides in the yuan have previously triggered capital flight and strong capital market fluctuations and the central bank will almost certainly act to avoid a rerun.
Macro & Finance
The State Council said last week that China would take a more active fiscal policy posture and pledged to accelerate local governments’ special bond issuance for infrastructure projects. Chinese stocks rallied higher Monday on speculation of a large-scale policy easing.
The shake-up of China’s $16 trillion asset management industry continued, with regulators releasing more-detailed guidelines that will ease concerns about the potential negative impact on liquidity in the economy as financial institutions rush to comply with sweeping new rules released in April.
Three of China’s “big four” state-owned banks announced they are investing in a multibillion-dollar state-backed fund tasked with increasing financing to small businesses, agriculture-related enterprises and innovative startups, as part of the government’s campaign to boost funding for cash-starved areas of the economy.
The Hong Kong Stock Exchange operator decided to put off a debate on proposed rule changes that would allow corporate shareholders to retain shares with more voting rights — a broadening of its recent decision to permit “weighted voting rights” to company founders.
Issuance of residential mortgage-backed securities (RMBSs) shot up during the first half of the year due to rising demand for home loans and growing investor appetite for lower-risk products.
China’s securities regulator wants to ban securities firms and fund managers from engaging in the “channeling business” that is specifically aimed at helping clients circumvent regulations designed to protect the financial system.
China’s tight restrictions on stock-index futures trading will be relaxed to increase investors’ ability to hedge against risk, after the country’s bourses slumped over the past two months on trade tensions and economic slowdown fears.
China’s Great Wall Asset Management Co. Ltd. will receive a capital injection of 12.121 billion yuan ($1.79 billion) from four strategic investors.
Chinese group-buying site Pinduoduo Inc. made a strong debut on the Nasdaq Stock Market on Thursday, following a $1.63 billion initial public offering that was one of the biggest flotations by a Chinese enterprise this year. The shares closed 40% higher than their $19 IPO price at $26.7.
Shares in mobile big-data provider Jiguang, formally known as Aurora Mobile Ltd., ended their first trading day in the U.S. 3.5% higher than their offer price.
Shares in several mainland-listed drug-related stocks have tumbled amid an explosive scandal involving the administration of shoddy vaccines to hundreds of thousands of children in China.
July 31: NBS releases manufacturing Purchasing Managers Index (PMI), non-manufacturing PMI, and Composite PMI Output Index for July
August 1: Caixin releases the Caixin China General Manufacturing PMI for July
August 3: Caixin releases the Caixin China General Services PMI and the Caixin China Composite PMI for July
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