With the expectation that Federal Reserve's policy will continue interest rate hikes, the sharp drop in U.S. stocks and the rise in the U.S. dollar have led to a new round of decline in the Chinese yuan (renminbi, RMB) exchange rate. On August 29, data from the China Foreign Exchange Trade System (CFETS) showed that the central parity of the RMB against the USD was reported at 6.8698, a depreciation of 212 basis points, the lowest since August 28, 2020. At that time, the RMB market exchange rate continued to decline. At 17:00 Beijing time, the onshore RMB exchange rate was at 6.92, a depreciation of 0.7% from the previous trading day. At the same time, the offshore RMB was reported to be at 6.9282, a depreciation of 0.49%. The USD index broke through 109 and rose to 109.29 on the same day. Since the beginning of this year, the trend of the RMB exchange rate appears to be volatile, and this has since intensified significantly. At the beginning of the year, it once rose to the level of 6.30. At the end of April, the market fell sharply. By mid-May, it fell to around 6.80. After that, it rebounded to around 6.70. In August, it began to accelerate downward again, breaking through the high of 6.9, just one step away from reaching 7.00.
In regard to the reasons for the depreciation of the RMB exchange rate, a recent article by Guan Tao, Global Chief Economist at BOC International China, listed several influencing factors. The main negative factors include the rebound of the COVID-19 outbreaks, the disposal of financial risks, the slowdown of economic recovery, aggressive tightening abroad, the global economy's stagflation, international financial turmoil, geopolitical conflicts, and so on. Researchers at ANBOUND believe among these factors, two are the most crucial ones. The first is that China's measures against COVID-19 have dragged down the economy, and the second is the appreciation of the USD under the strengthening of the USD policy. As previously pointed out by ANBOUND, due to the shifts in the external monetary environment and the international economic situation, especially changes in the Fed's policy expectations, there have been adjustments in the global market. This causes major currencies in the world, including the RMB, to depreciate against the USD. At the same time, the weakening of China's own economy and the intermittent outbreaks of COVID-19 have caused international investors to modify their expectations for the country's economic growth. This, in turn, contributes to the depreciation of the RMB.
ANBOUND has also noticed that this round of RMB exchange rate depreciation is rather different from the rapid depreciation in May. On the one hand, the current depreciation is dominated by the strong USD brought about by the Fed's strong interest rate hike policy. The EUR, JPY, and RMB, which have policy differences with the Fed, have all depreciated. To a certain extent, this has divided the pressure of the USD on the RMB. On the other hand, China's economy is showing signs of "bottoming out" as cases of COVID-19 continue to be reported. Although it will take time for the country to recover, it still shows China's stable resilience as a whole. Therefore, under the full expectation of the market, the devaluation of the RMB has not caused excessive panic both inside and outside of China. In addition, short-term speculative trading of the RMB has been greatly reduced in the context of the Chinese central bank's repeated influence on the market and its push for the RMB's two-way volatility. Because of these reasons, especially considering the stability of China's economy and market, the room for the continued devaluation of the RMB still appears to be limited. In particular, China's foreign trade has continued to show a surplus in recent months, laying the foundation for the long-term stability of its currency.
However, for the same reasons mentioned above, researchers at ANBOUND believe that in the current international and domestic context, the devaluation of the RMB will still be a phased trend, and it is unlikely to reverse in the short term. Under the circumstance that it would be improbable for U.S. inflation to fall quickly, the Fed will continue to adopt tightening policies as expected. Such a trend decides that it would be difficult for the RMB to resist the influence of the strong dollar and reverse the direction of the exchange rate. Although the devaluation of the Chinese currency is beneficial to the country's foreign exports, as Guan Tao noted, under the current situation of a strong dollar, foreign trade will not play a leading role in short-term capital flows. Guan Tao believes that the large trade surplus has enhanced China's ability to resist capital flow shocks, but the trade surplus needs to be gradually accumulated. In addition, the pressure of capital outflow may be released instantly, and this mismatch may still put pressure on the RMB. In the short term, China's capital market is not only affected by the overall economic downturn but also by the "prudent" monetary policy. There is no sign that this is attractive to investors, hence difficult for it to continue attracting international capital inflows.
According to Guan Tao, whether the RMB will continue to adjust downwards depends on if the factors affecting the exchange rate are bearish or bullish. Moreover, the increased flexibility of the exchange rate will help to release market pressure and avoid the accumulation of expectations, where the market long-short switch can be completed fast. This actually means that changes in market volatility may still be very drastic, making short-term transactions in the capital market riskier. With the strengthening of the USD and the devaluation of the RMB becoming a major trend, it is critical for China to maintain the stability of market expectations, so as to avoid a series of shocks caused by exchange rate fluctuations and affect economic stability.
China's macro policy is also constrained by the Mundell-Fleming trilemma. Under the circumstance of maintaining the continuity of opening up and the interest rate policy focusing on the country itself, it is an inevitable compromise for the country's macro policy to release pressure through exchange rate depreciation. Therefore, its exchange rate policy and monetary policy should follow the trend, focusing on stabilizing the market and avoiding panic and "derailment" in the process of achieving a new balance. More importantly, the Chinese policymakers will need to take into account the uncertainty brought about by the COVID-19 pandemic, grasp the balance between pandemic control and economic stability, as well as avoid the serious consequences of the sharp depreciation of RMB assets due to exchange rate fluctuations caused by the economic stall.
Final analysis conclusion:
Against the backdrop of a strong dollar and a weak Chinese economy, the RMB exchange rate will embark on a phased depreciation trend. Although the room for depreciation will be limited, this trend will not be reversed in the short term. In the process of realizing the new internal and external balance of the RMB exchange rate, it is necessary for Chinese policies to maintain the stability of the capital market and of the economy, in order to prevent panic caused by unstable expectations and the risk of "derailment".
