Fx flash usdcny 6 80 target approaching 8 november 2016

FX Flash

Group Economics Macro & Financial Markets Research

08 November 2016

USD/CNY 6.80 target approaching  China FX reserves in October declined at a faster pace

Roy Teo

 Positive correlation between CNY TWI and USD TWI has broken down

Senior FX Strategist Tel: +65 6597 8616

 2016 year end USD/CNY 6.80 target approaching

roy.teo@sg.abnamro.com

China FX reserves in October declined at a faster pace China’s foreign currency reserves declined by USD 45.68bn in October, more than double the fall recorded in August (USD 15.89bn) and September (USD 18.79bn) combined. We attribute the sharper decline in FX reserves due to larger capital outflows (due to firmer yields in the US) and valuation effects (stronger US dollar).

Decline in FX reserves partly due to a stronger USD Index level

Reverse scale USDbn

105

Capital outflows likely to have increased in October %

USDbn

2000

2.0

100

2500

1.5

50

90

3000

1.0

85

3500

100 95

80 4000

75 70 Jan-10

4500

Jan-12

USD index (lhs) Source: PBoC, Bloomberg

Jan-14

Jan-16

0 -50

0.5

-100

0.0 -0.5 Jan-10

-150 -200

Jul-11

Jan-13

Jul-14

Jan-16

10y CN-US yield spread % (lhs)

China FX reserves USDbn (rhs)

Estimated capital flow USDbn (rhs) Source: Bloomberg

Positive correlation between CNY TWI and USD TWI has broken down Historically the Chinese yuan trade weighted index (CNY TWI) and the US dollar trade weighted index (USD TWI) tends to move in tandem (positive correlation) due to China policy makers preference for a less volatile currency. However this relationship has broken down in the past month. This is unusual. The CNY TWI has been relatively steady when the USD TWI strengthens. In our view, this is a reflection that China policy makers are letting market forces play a larger role in the direction in the CNY. However when the USD TWI declines, so does the CNY TWI. This is probably a reflection of China’s policy intent to engineer a gradual depreciation in the CNY. Indeed since October, the CNY TWI has

Insights.abnamro.nl/en

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FX Flash - USD/CNY 6.80 target approaching - 08 November 2016

declined by about 0.5% while the USD TWI has strengthened by more than 2%. Having said that we maintain our view that China will continue to smooth volatility in the currency via intervention activities in the spot market as reflected by a rise in trading volume in October.

CNY TWI and USD TWI

Intervention activities likely have increased in October

Index level

1mth realized volatility

102

4

100

3

98

2

1000000 800000 600000 400000

96

1

94 92 Jan-16

USDm

200000

0

0 Jan-16

Mar-16

May-16

USD Index (DXY) Source: CFETS, Bloomberg

Jul-16

Sep-16

CFETS CNY TWI

Nov-16

Mar-16

May-16

Jul-16

Sep-16

CFETS USD/CNY spot trading volume USDm (rhs) 1 month USD/CNY realized volatility (lhs) Source: CFETS, Bloomberg

2016 year end USD/CNY 6.80 target approaching Our view that the onshore yuan (CNY) and offshore yuan (CNH) will decline to around 6.80 and 6.83 against the US dollar by the end of this year is materializing.

This is reflected by both the onshore and offshore yuan forwards market. We expect depreciation pressures in the yuan to decline next year due to an improvement in domestic inflation and exports outlook. Deleveraging and restructuring large corporate debt remain a risk. Our 2017 year end USD/CNY target is 7.0.

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FX Flash - USD/CNY 6.80 target approaching - 08 November 2016

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FX Flash - USD/CNY 6.80 target approaching - 08 November 2016