FX Watch
Group Economics Macro & Financial Markets Research
7 January 2016
Gradual depreciation in CNY TWI Roy Teo Senior FX Strategist Tel: +65 6597 8616 roy.teo@sg.abnamro.com Arjen van Dijkhuizen Senior Economist Tel: +31 20 628 8052 arjen.van.dijkhuizen @nl.abnamro.com
Depreciation in CNY has triggered devaluation fears
CNY TWI stronger than justified by economic fundamentals
We expect a gradual depreciation in the CNY TWI
Sharp depreciation in yuan will result in financial instability
2016 year end USD/CNY forecast revised higher from 6.55 to 6.70
2016 year end USD/CNH forecast revised higher from 6.57 to 6.73
Depreciation in CNY has triggered devaluation fears Since November last year, the Chinese yuan (CNY) trade weighted index (TWI) has depreciated by almost 3%, triggering market concerns that the People’s Bank of China (PBoC) is seeking to devalue the currency to support the economy.
CNY trade weighted index Index level
106 105 104 103 102 101 100 99 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 CNY Index
Source: CFETS, ABN AMRO
The depreciation in both the onshore yuan (CNY) and offshore yuan (CNH) has persisted longer than expected. This could be due to several reasons. First, the PBoC has allowed a weaker CNY daily fix since November last year, in line with broad US dollar strength against most currencies. This probably signals that the central bank has shifted its focus towards measuring the CNY strength against a basket of currencies rather than the US dollar. A higher USD/CNY fix has also resulted in stop losses being triggered, amplifying
Insights.abnamro.nl/en
2
FX Watch – CNY index implies weaker CNY?– 15 December 2015
the bearish momentum in the CNY. The sharper pace of depreciation in the CNH is partly due to unwinding of leveraged structured products (based on CNH) barriers being triggered. Second, economic data in December came in weaker than expected. This has reignited market fears that despite previous monetary and fiscal stimulus, headwinds to the economy continue to persist. We like to highlight that the weak economic data in December could be partly due to elevated smog in Beijing which resulted in some industrial plants being closed and service sector being impacted. Last but not least, the PBoC’s tolerance level towards volatility in the yuan and divergence between the CNH and CNY may be higher as they seek to allow the currency to be more market determined and reduce their intervention activities after the yuan had been formally included into the SDR basket as of 30 November 2015. What does CNY at a ‘reasonable level’ means? PBoC vice governor Yi Gang has recently stated that China is capable of keeping the yuan’s exchange rate at a ‘reasonable level’ and sees no basis for continued depreciation. In our view the PBoC is referring to the CNY TWI rather than the CNY against the USD as the former better capture the competitiveness of China’s goods and services. Based on Bank of International Settlements (BIS) metrics (more historical data compared to CFETS TWI which has data back to only 31 December 2014), the CNY nominal effective exchange rate (NEER) has risen more sharply than justified by China’s current account surplus as a percentage of GDP. The CNY NEER is also more than 1 standard deviation stronger than 20 year average. Hence a ‘reasonable level’ may imply a weaker CNY against its trade weighted basket of currencies going forward.
CNY NEER and China’s current account surplus Index level
%
130
12
120
10 8
110
6 100
4
90 80 Mar-05
2 0 Mar-07
Mar-09
CNY NEER (lhs)
Mar-11
Mar-13
Mar-15
Current account % GDP (rhs)
Source: BIS, Bloomberg
Sharp depreciation in yuan will result in financial instability While there are economic reasons for a weaker CNY TWI to support exports and inflate the economy, a sharp depreciation in the yuan will result in an acceleration of capital outflows and financial instability. Domestic companies’ debt repayment of foreign currencies liabilities will also be magnified if the yuan depreciates sharply.
3
FX Watch – CNY index implies weaker CNY?– 15 December 2015
Estimated capital flow in China USD bn
100 50 0 -50 -100 -150 -200 -250 Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Estimated capital flow USDb (lhs) Source: Bloomberg
The PBoC has also stated that they will not hesitate to intervene in the event of drastic fluctuation or abnormality in international balance of payments and cross-border capital flow. Indeed volatility in the yuan has spiked recently, though levels remain below the peak seen in August last year when the PBoC surprised financial markets by implementing a new daily yuan fixing mechanism which better reflects market forces.
1 week USD/CNY and USD/CNH realized volatility Realized volatility
25 20 15 10 5 0 Jan-15
Apr-15
Jul-15
1 wk USD/CNH volatility
Oct-15
Jan-16
1 wk USD/CNY volatility
Source: Bloomberg
Fiscal and monetary stimulus should reduce need for sharp depreciation in the CNY The government has also stated that fiscal stimulus will be increased to support the domestic economy. Policies to boost trade are also likely to be implemented in the coming months. It is also worth noting that the slower pace of gains in the CNY TWI in the second half of 2015 should support export growth, supported by an improving global economy. In addition, we also expect the PBoC to further increase monetary stimulus this year. This could materialise as soon as this weekend. Inflation is also expected to rise from 1.5% in 2015 to 2% in 2016 as domestic consumption improves, supported by firmer commodity prices and a weaker yuan. CNY implementation in SDR and China current account surplus to support CNY The implementation of the CNY in the IMF Special Drawing Right basket on 1 October 2016 will also support the CNY due to potential increase in central banks’ demand for the yuan. The demand for the CNY will also increase as more foreign investment in domestic
4
FX Watch – CNY index implies weaker CNY?– 15 December 2015
bonds are allowed. The latter will scale up the bond market capacity and facilitate a swap of shadow banking credit to transparent bond financing (IMF). China’s current account surplus will also increase due to lower commodity import prices. This should provide some support to the CNY. Implications for yuan forecasts – more bearish On balance, a gradual depreciation in the CNY TWI is likely to be more prudent in our view. Given that we expect the USD to appreciate against most currencies this year, the yuan is likely to depreciate more against the USD than previously assumed. Our 2016 USD/CNY and USD/CNH year end forecasts have been raised to 6.70 (from 6.55) and 6.73 (from 6.57) respectively. Nevertheless, our new yuan forecasts are still less bearish than what is priced in by financial markets (above 6.90). We maintain our view that the current bearish momentum in the yuan is overdone and extreme. Indeed despite selling pressure in the yuan spot market, the options market demand to hedge further weakness in the yuan has been declining since October last year. We also expect the CNH discount to the CNY to gradually narrow to historical average of around 300 pips as sentiment in the yuan improves later this year. A large discrepancy between the CNH and CNY is not desired as it will reduce the attractiveness of the CNH as a hedging currency. We expect the CNY to recover slightly against the USD in 2017 given our view that the USD will underperform against most currencies next year.
1 year USD/CNH and USD/CNY NDF outright Level
7.0 6.8 6.6 6.4 6.2 Jan-15
Apr-15
Jul-15
1 year USD/CNH outright
Oct-15
Jan-16
1 year USD/CNY NDF outright
Source: Bloomberg
USD/CNY and USD/CNH forecasts
USD/CNY (onshore) USD/CNH (offshore)
07-Jan Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q4 2017 6.59 6.55 6.60 6.65 6.70 6.60 6.69 6.65 6.65 6.70 6.73 6.60
Source: ABN AMRO Group Economics
5
FX Watch – CNY index implies weaker CNY?– 15 December 2015
Find out more about Group Economics at: https://insights.abnamro.nl/en/
DISCLAIMER ABN AMRO Bank Gustav Mahlerlaan 10 (visiting address) P.O. Box 283 1000 EA Amsterdam The Netherlands
This document has been prepared by ABN AMRO. It is solely intended to provide financial and general information on economics. The information in this document is strictly proprietary and is being supplied to you solely for your information. It may not (in whole or in part) be reproduced, distributed or passed to a third party or used for any other purposes than stated above. This document is informative in nature and does not constitute an offer of securities to the public, nor a solicitation to make such an offer. No reliance may be placed for any purposes whatsoever on the information, opinions, forecasts and assumptions contained in the document or on its completeness, accuracy or fairness. No representation or warranty, express or implied, is given by or on behalf of ABN AMRO, or any of its directors, officers, agents, affiliates, group companies, or employees as to the accuracy or completeness of the information contained in this document and no liability is accepted for any loss, arising, directly or indirectly, from any use of such information. The views and opinions expressed herein may be subject to change at any given time and ABN AMRO is under no obligation to update the information contained in this document after the date thereof. Before investing in any product of ABN AMRO Bank N.V., you should obtain information on various financial and other risks and any possible restrictions that you and your investments activities may encounter under applicable laws and regulations. If, after reading this document, you consider investing in a product, you are advised to discuss such an investment with your relationship manager or personal advisor and check whether the relevant product –considering the risks involved- is appropriate within your investment activities. The value of your investments may fluctuate. Past performance is no guarantee for future returns. ABN AMRO reserves the right to make amendments to this material. © Copyright 2016 ABN AMRO Bank N.V. and affiliated companies ("ABN AMRO").