The renminbi has taken the deterioration in US-China trade relations hard. It has depreciated by nearly 3% from its mid-April levels. For the last two weeks of May it held in a CYN6.90-6.92/USD range. Further pressure should be expected.
It is looking less and less likely that a trade agreement will be achieved. However, the bigger question is, even if an agreement is negotiated, will financial markets expect it to persist? Our previous advice was contrary to the consensus view reflected in the predicted renminbi appreciation from end-November to March. We argued that while a trade agreement would be relatively easy to achieve, realistically, ensuring compliance would be a critical vulnerability. Therefore, any post-agreement euphoria should be ‘rented’ rather than ‘bought’.
This remains our expectation with the modification that financial markets are now likely to be much more cynical, even if a deal is forthcoming. Trade tensions and, more broadly, the combination of economic and geopolitical US-China rivalry, should be regarded as permanent.
The political calendars of both the US and China – in China the 70th anniversary of CCP rule and the 2020 presidential election in the US – will serve to escalate tension. Heading towards the 1 October anniversary, China is likely to continue to offer a robust response to US aggression. Trump clearly sees taking a hard line with China as offering political advantage and the Democratic response will be to turn more hawkish to match him.
On this basis, pressure on the renminbi is likely to continue. While the negotiations were ongoing, the PBoC was constrained to keep the yuan “stable”. This constraint is now lifted.
This does not mean, however, that renminbi weakness is being courted. On the contrary the recent behaviour of the exchange rate suggests that the central bank is reluctant to allow the renminbi a free float downwards. The issue remains, as it was last year, that the currency is a hybrid. It is increasingly allowed a free float but its legacy as an administered currency means that the central bank still has to be careful to avoid being seen as sanctioning weakness that would encourage momentum trades against the currency.
Efforts to restrain renminbi weakness increased in 2018 as the exchange rate approached CNY7/USD and this appears to be repeating this year. The reasoning is purely psychological. A new “big figure” would be a highly visible sign of weakness escalating the risk from momentum. One might argue that allowing the renminbi to depreciate through 7 on market forces would be a sign of confidence, but it is one that the PBoC does not appear willing to risk yet.
Squeezed between persistent trade tensions and a still cautious central bank, the renminbi is likely to trade sideways. Risk is asymmetric and currency depreciation is the textbook response to the imposition of tariffs. However, our central case is that the bulk of renminbi depreciation has already happened.
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