Chinese policymakers fired a “cross-arch” shot in the currency markets this week in an attempt to slow the rise in its currency. This move could work in the short term, but fundamentals should favor a stronger renminbi in the long term, analysts say.

Last week, the Chinese currency traded at less than 6.40 yuan to the dollar, its highest level since 2018. Over the past year, the renminbi USDCNY,
+ 0.16%

USDCNH,
+ 0.08%
appreciated more than 12% against the dollar. Although the terms are often used interchangeably, the renminbi is China’s national currency, while the yuan is the unit of account.

After a series of public statements aimed at curbing the currency’s rise, the People’s Bank of China took more concrete action on Monday by increasing the foreign exchange reserve requirements for banks, effective June 15.

As a result, local banks will be forced to buy and hold more foreign currency on their balance sheets. McKenna, international economist at Wells Fargo, in a note Wednesday.

Why has the renminbi been so strong? Look at the fundamentals.

The COVID-19 cases have been contained, allowing the Chinese economy to operate at full capacity and national mobility to return to pre-pandemic levels, McKenna said.

Economic indicators have rebounded faster than its emerging market counterparts in China, as well as most developed economies, allowing China to become a “safe haven” in emerging markets and a destination for investor capital flows. foreigners, he noted.

In turn, the renminbi has benefited from the recovery in capital flows, McKenna said. The economic recovery has also boosted Chinese sovereign debt yields, which have reached pre-pandemic levels and offer positive real or inflation-adjusted interest rates. With consumer price inflation in China below 1%, real yields on medium and long-term bonds are around 2.2%, compared to negative real interest rates in the United States.

“In today’s low interest rate environment, investors are in a ‘search for yield’ mode,” McKenna wrote. “With local currency debt in China offering attractive yield dynamics, foreign investors quickly deployed capital on Chinese sovereign debt, which has also supported the renminbi over the past year. ”(See table below.)

Wells Fargo Securities


But keep the currency movements in perspective. Carl Weinberg, chief economist at High Frequency Economics, noted that the currency remains within its official trading range, which is defined as a range against a basket of currencies.

While the renminbi has hit the bottom of the range three times in the past five years, it has not even tested the top of the range and is currently around two-thirds of the way up, he said. he stated in a note on Tuesday.

“So the problem for the yuan is not that it is appreciating globally, but rather that the dollar has depreciated by about 11% against its trade-weighted basket over the past year. “Weinberg noted. “The yuan only rose 0.8% year-on-year against the euro EURCNY,
-0.04%,
for example.”

Meanwhile, a stronger currency against the dollar has its advantages. This reduces the costs of commodities and other commodities denominated in dollars as the economy reopens, helping to offset inflationary pressure on domestic prices from rising oil and industrial prices, Weinberg said.

The downside is that Chinese export prices are higher in dollars, although investors should keep in mind that the United States currently accounts for a small part, perhaps 15%, of Chinese exports, Weinberg said. .

Weinberg is not convinced that official China is anything that has worked on a stronger currency against the dollar.

Societe Generale analysts saw the decision to increase the foreign exchange reserve requirement ratio as a sign of unease over the strength of the renminbi. After all, such movements are rare. The last hike was in 2007, when capital inflows were large and the currency appreciated rapidly, they noted, although the impact is expected to be limited.

“Higher foreign exchange reserve rates in China are a wake-up call to the forex market as the yuan appreciates, but the flow of money into Chinese bonds means the pressure is not going to suddenly go away,” they wrote.

McKenna of Wells Fargo saw additional action opportunities.

“In the future, it would not surprise us if the PBOC took further steps to disrupt the trajectory of the currency,” he wrote. “These actions could include buying US dollars and increasing the stock of foreign exchange reserves of the PBOC, encouraging state banks to buy US dollars as well as stepping up verbal intervention efforts. “

Weinberg, meanwhile, argued that balance-of-payments issues were likely the main driver of the currency’s strength against the dollar. In particular, the use of the yuan along the Silk Roads to finance infrastructure and conduct business transactions has increased its value and will continue to do so.

China has become a world leader in lending to emerging economies, and the repayment of these loans in yuan increases the demand for currency, while net income from other foreign direct investments is converted into yuan when repatriated. , did he declare.

“As a currency adapts to international uses, it naturally appreciates as demand increases,” he writes.

It’s a process that should continue, Weinberg argued.

“There will be ups and downs along the way, but we believe the yuan is on an unstoppable ascent to global transaction currency status,” he wrote. “It will increase on all cross rates as its uses around the world increase in volume.”



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