Battle lines are being drawn in Beijing — in a way no one expected this year. On one side are traders ready to bet there is not much the central bank can do to limit the renminbi’s remarkable rally; on the other is the People’s Bank of China, whose heavy hand and ability to control the market are well known.
On Friday the renminbi raced to a new high against the US dollar. On Monday central bank actions halted the rally in its tracks. But for how long?
The renminbi has gained nearly 7 per cent this year compared with a fall of 6.5 per cent in 2016, wrongfooting analysts who had uniformly bet it would weaken steadily in 2017. Last week the onshore rate touched a 21-month high of Rmb6.4349 against the dollar. And it is the onshore market — the one most tightly controlled by the PBoC — that is driving the rally, in sharp contrast to the past two years when the offshore market has tended to lead its mainland cousin.
On Monday the renminbi retreated after news the central bank had dropped a reserve requirement on onshore banks’ forward currency contracts that was introduced in 2015. Abolishing the requirement makes it easier for banks in effect to short the renminbi, which could curb the currency’s rally.
The question now is whether the move was merely the PBoC’s opening salvo or the best it could do. Tellingly, the central bank set Monday’s “fix” of the mainland market — the midpoint around which the renminbi is allowed to trade 2 per cent to each side — at a stronger level than on Friday. In theory, if Beijing were deeply unhappy it would signal this via an unexpectedly weak fix.
“There is a feeling in China that authorities’ options may be limited in the next few weeks because if they do something that generates an adverse reaction overseas, it becomes political and officials don’t want that before the party congress,” says Mansoor Mohi-uddin, strategist at NatWest markets. “So the fix is what everyone is watching — that is where we will see authorities’ signals.”
The problem for the PBoC, assuming that it would like to at least curb the renminbi’s rally, is that it faces a number of headwinds, of which the October party congress is just one. That meeting marks the start of President Xi Jinping’s second term and will see the unveiling of China’s new leadership team.
Beijing’s well-known dislike of market volatility, especially around its big set-piece events, has spurred an unusual trading idea for the renminbi — that of it acting as a potential haven. With tensions rising related to North Korea, haven-seekers are wary of the yen, the region’s traditional refuge, since any escalation is likely to affect Japan.
“That renminbi strength is occurring at the same time as rising geopolitical tension in the Korean peninsula is a key indication that the Chinese authorities are displaying commitment to maintain financial market stability,” says Christy Tan, head of markets strategy for Asia at National Australia Bank. “This may not be a permanent policy stance, but perhaps could be maintained until the [congress].”
The renminbi’s rally has been generating intense market interest. Average mainland currency trading volumes rose 16 per cent last month, according to analysts at CICC, and reached their highest levels since December last year when China clamped down on capital outflows.
Chinese companies may also provide another headwind for the PBoC and may be adding to the renminbi’s rally. Bearish views on their home currency earlier in the year led many executives in China to stockpile dollars in the expectation the exchange rate would only worsen — a view that is now costing them dearly.
Mr Mohi-uddin says banks and investors he met on a mainland trip this month estimate that companies may only be halfway through selling excess dollars, implying more onshore pressure on the dollar to come.
Citigroup’s Lu Sun, visiting clients in Shanghai last week, says there has been an “obvious shift” in onshore expectations for the renminbi in just the past month.
“The entrenched bearish renminbi view has been smashed by the aggressive dollar-renminbi price actions,” she says. “Clients now generally hold stable or mild positive views on the renminbi in the near-term, though [the] long-term bearish view is still far from extinguished.”
Underpinning the gains throughout this year are the draconian capital controls imposed by China at the end of last year that have curbed the outflows generated by bearish views on the renminbi.
China’s foreign exchange reserves have risen for seven straight months as a result of the controls, which until recently had allowed investors to dismiss the renminbi’s rally as a product of official engineering as well as merely the flipside of broad dollar weakness.
But more recently, renminbi gains have outpaced the dollar’s slide. Since the end of July the renminbi has risen 4.2 per cent while the trade-weighted dollar has dropped 1.8 per cent. Even the renminbi’s trade-weighted value — the measure compiled by the PBoC through its CFETS system — has gained, jumping 1.8 per cent over that time in an unusually large move.
“For the past year the CFETS index has been roughly stable so to see it moving now implies something has changed in China,” says Mitul Kotecha, head of Asia currency and rates strategy at Barclays, who suggests that allowing a stronger currency could take some of the pressure off China in its trade talks with the US. “The onshore market is clearly pushing for a stronger renminbi but I think the authorities might be, too.”