China is leaning really – really – hard into the counter-cyclical adjustment factor in an apparent bid to keep the yuan stable amid trade tensions that sent USDCNH to an all-time high earlier this week.
Friday’s tariff escalations and Donald Trump’s exceedingly aggressive rhetoric set up the offshore yuan to hit a record low against the dollar once trading got going in the new week. Confused messaging from the administration on Sunday at the G-7 didn’t help.
The yuan is on track for a record loss this month, falling nearly 4% against the greenback. The currency is the weakest since 2008.
While the White House would likely point to that as evidence of the Chinese continuing to devalue in an effort to blunt the effects of the tariffs, the reality is that Beijing is going out of their way to foster stability and thereby avoid throwing gas on the fire, something Steve Mnuchin doubtlessly knows, even if Trump doesn’t understand the mechanics.
The fix has come in stronger-than-expected for days on end, and today’s can almost be described as anomalous. “China’s fix blows all previous ones out the water”, former Goldmanite and IIF Chief Economist Robin Brooks remarked. At 7.0835, the fixing was stronger than every estimate, with the range spanning 7.0887 to 7.1315. The average was 7.1126.
Brooks went on to marvel at the “unprecedented residual” shown in the chart below.
“Significant CNY depreciation today calls out for significantly stronger-than-expected fixings in coming days if policymakers wish to push back on further depreciation”, Goldman wrote, in a note out Tuesday, on the way to adjusting their 3, 6 and 12 month USDCNY forecasts to 7.20, 7.20 and 7.10, respectively (from 7.05/7.05/7.00).
China seems to believe this month’s pace of depreciation was too rapid, and the recent escalations risked things spinning out of control. Although some believe Beijing learned enough from the 2015/2016 experience to keep capital flight from becoming a problem again, it doesn’t look as though they want to chance it just yet.
“As China’s current account surplus declined, the stability of the RMB has been more dependent on foreign portfolio inflows than before”, BofA cautioned in a Tuesday note, warning that “a depreciation bias by the PBOC runs the risk of causing foreigners to withdraw capital from onshore assets and limit potential inflows”.
Still, the messaging is a bit muddled. The IIF’s Brooks on Tuesday morning reiterated that “we’re entering uncharted territory on RMB, given that the gap between the fix and $/CNY close points to depreciation pressure”, but the pace of spot depreciation contrasts with the fix, which telegraphs a desire for a more controlled, gradual pace. The yuan has closed weaker than the fix every day but one in August.
BofA described recent dynamics as follows:
1) an initial overshooting of RMB depreciation, especially in USD/CNH, 2) a pullback in the USD/CNY and USD/CNH rates as the USD/CNY fixing rate is increased at a gradual pace, 3) Upward momentum in the USD/CNY fixing rate is contained by the countercyclical component, 4) A gradual rise in USD/RMB after the pullback.
For the bank, USDCNY has a date with 7.50 by the end of the year. That’s weaker than their previous forecast of 7.30. Notably, BofA says that if Trump were to slap a 30% tariff rate on the $300 billion in goods that are, from September 1 and December 15, subject to a 15% duty, it’s possible the yuan could depreciate all the way to 8.19 in order to offset the effects of the tariffs.
All of this leads one to wonder what might happen in the event the PBoC sets the fix somewhere in the neighborhood of estimates in the days ahead, as opposed to deploying the CCAF to ensure things stay stable. One errant tweet from Trump might well tempt Beijing to release the hounds (so to speak), just as they did on August 5.
After all, China can always just step in and sell dollars if things get out of hand, or sell bills in Hong Kong to scare away any bears that get overly ambitious.
“Depreciation bias [should] sustain in the near-term” and while “CNY is unlikely to be used as a retaliation tool, a move to around 7.30 is likely on trade tensions”, UBS wrote Wednesday, adding that “the pattern of daily fixings signals the authorities want to avoid a sharp depreciation”.
For now, but as the IIF’s Brooks flatly states in conjunction with the chart of the residuals shown above, “the decoupling of the actual $/CNY exchange rate from the fix” is becoming increasingly “unsustainable”.