Search ForexCrunch

Analyst Hao Zhou at Commerzbank noted that CNY has caught a lot of attention recently as China and US are set to resume the trade talks.  

Key Quotes:

“CNY is again in the spotlight.”

“The PBoC has introduced several so called “counter-cyclical measures” as the 7.00 hurdle in USD-CNY is under threat. Given so many things are going on, we think that the market has to prepare for more volatility ahead.”

“China and the US have agreed to kick off the new round of trade talks next week (22 and 23 August). While many remain skeptical about the results as China only sends a low-level delegation led by Vice Commerce Minister Wang Shouwen, the market seems to see this as a positive development as this will be the first formal talk since the US imposed tariffs on $50bn Chinese goods and threatened tariffs on an additional $200bn.”

“There is some further information that the US wants China to manage USD-CNY back to pre-dispute levels, which might point to the 6.3-6.4 levels seen in the second quarter of this year. This sheds a different light on the PBoC’s efforts to limit the upside in USD-CNY. The increased efforts could be seen as an attempt to appease the US negotiation partners ahead of next week’s talks.”

“The Chinese authorities have introduced several counter-cyclical measures to safeguard their currency.”

“The PBoC Shanghai office asked banks in the Shanghai Free Trade Zone (FTZ) to stop offering renminbi to offshore CNH inter-bank market. The Shanghai FTZ was established in 2013 in order to accelerate CNY internationalization and is designed as a bridge to connect the onshore CNY market and the offshore CNH market. While the pace of CNY internationalization has somewhat halted since the “one-off devaluation” in 2015 due to the substantial interventions that were needed to stop the subsequent capital flight, the FTZ is still an important liquidity provider for the CNH market.”

“There has been a liquidity squeeze in the CNH market since the introduction of the most recent efforts to slow down CNY depreciation, which has significantly pushed up the USD-CNH forward curve and increased the cost of shorting CNH as a result.”

“In its Q2 monetary policy implementation report, the central bank has furthermore confirmed to adopt counter-cyclical measures to prevent “herd behavior” in the market. Earlier this month, the PBoC had already re-imposed the reserve requirement for shorting CNY in the forward market. Notably, the USD-CNY fixing rates this week came in well below our and the market’s expectations, illustrating the policy intention to achieve a stable currency.”

“The PBoC’s management reminds the market of the massive market intervention that took place over the past three years. In the end, these measures were successful in stopping the capital flight and reversing CNY-weakness; so the re-introduction is a clear signal to the market that it is not worth betting against the PBoC.”

“This time around, all these actions suggest that China’s central bank will defend the psychological level of 7.00.”

“The cost of “letting the currency go” is unbearable as it is likely to lead to market chaos and uncontrollable capital outflows. Things could become much worse given the backdrop of escalating trade tensions and the Turkey crisis.”

“It makes more sense for China to maintain stability, rather than triggering another round of market sell-off.”

“The big question is whether China’s authorities will indeed be willing to appreciate their currency on a lasting basis to appease the US.”

“This could easily de-escalate the trade conflict without China having to implement promptly more disruptive liberalization measures that could endanger domestic stability.”

“However, if China could as easily manage its currency as it wishes, it wouldn’t have to implement so many counter-cyclical policies to defend the 7.00 hurdle. It is extremely difficult, if not impossible, to permanently steer the currency away from market equilibrium.”

“A generally softer CNY is justified from both economic and markets perspective: China’s growth is clearly hitting a soft patch, and its current account surplus is shrinking.”

“In the meantime, the US dollar looks quite firm given the Fed is still in the rate hiking process. Hence, CNY is still under depreciation pressure over the foreseeable future.”

“We consider it highly unlikely that there will be a deal involving CNY at the US-Chinese trade talks next week. However, if it becomes apparent that CNY is an issue in the negotiations, this could strengthen market expectations that the PBoC is even more determined to limit the upside in USD-CNY. This expectation could already be sufficient to dampen the depreciation pressure on CNY. On the other hand depreciation pressure could pick up again, if next week’s talks fail to produce any hopes for a more lasting de-escalation in the trade conflict.”

“The CNY outlook becomes more complex given the new developments recently. We think that the market has to prepare for more volatility ahead, indicating at the same time that the PBoC will stay vigilant.”

“We still believe that the PBoC will succeed in stabilizing USD-CNY below 7.00 until year-end.”