RMB: Mind the fix – Deutsche Bank

Research Team at Deutsche Bank, suggests that it took the moves around Brexit for China to allow a comprehensive break of 6.60 and after resisting for slightly over a month, it finally allowed 6.70 to break after coming back from the Golden Week holidays this week.

Key Quotes

“On the face of it, the strategy hasn’t changed. Back in June, PBoC took its time passing through the full dollar move in response to Brexit – around 10 trading sessions before the USD/CNY fix caught up with our model. We have seen a gap open up again this week, with the fix only passing through part of what the model would warrant. To be sure, the ~7% move lower in the TWI (CFETS basket) year to date (3%+ since just before Brexit) gives the authorities plenty of slack to accommodate moves in the dollar, or at least pace out the pass through into USDCNY. It would perhaps be easiest to conclude that this is business as usual in China FX, and that we can continue to ignore any risks from this source, like we have done for the better part of the last quarter (and arguably since March this year). And yet, there are also reasons to take more notice, because

• This will not be the first time China would have used a holiday period to mark a shift in strategy (recall the LNY period earlier this year). The authorities have lowballed the fix on at least three occasions over the past couple of months, when the model had signaled a break of 6.70. With the G-20 out of the way, as also the SDR inclusion, and the IMF meetings over the weekend, the timing of the break cannot be ignored.

• We are coming up to a period which is both lighter on the political calendar, and seasonally heavier on dollar demand. The event listings lighten up between the conclusion of the Sixth Plenary session of the 18th Communist Party on the 27th of October, and till the NPC around 5th of March. This could potentially give space for PBoC to allow for bigger moves on the RMB, as has been the pattern in the past. Again, November and January are seasonally also the weakest months for the RMB, with December in between relatively better on earnings repatriation by corporates (more unlikely this time, given concerns on the currency). As we approach year-end, USD demand tends to pick up driven by (1) the reset of total lending quota in China allowing corporates to borrow RMB loans more easily and to convert some of these loans into USD; (2) accumulation of dollars by banks ahead of Chinese New Year holiday in anticipation of pick up in credit card spending in foreign currency; and (3) the re-set of the $50k limit at the start of the year for locals to be able to buy foreign currency.
• Were markets to keep pushing away from the middle of the dollar smile – due to a combination of steeper DM curves, US political events, Brexit related concerns etc – the Chinese strategy of leaning against the markets to contain vol will arguably extract an increasing cost. Either in terms of credibility, if PBoC were to persist in deviating away from its fixing methodology, or reserves, were the authorities to guide the spot close such as to slow down the pass through of the broader dollar move into the RMB complex.

To be sure, none of these arguments shift the dial immediately on RMB becoming a systemic driver of global risk again. Our medium term strategic view hasn’t changed, and still argues for China leaning on a gradual and controlled depreciation of the currency versus TWI to help with the de-leveraging pressure within the economy, as against an outsized move versus the dollar (which would also put to risk the recent pick up in offshore interest in China fixed income). But its useful to remind ourselves that its a fine balancing act at any time, and in particular during periods of dollar strength. It would be arguably complacent to think that there is a limitless capacity to bear the costs associated with managing vol, and/or that the authorities would not be opportunistic in filling the gap versus the dollar move, particularly when markets are least watching.

To that extent, CNH funding bears watching in the coming few days, in whether it is squeezed to deter a further build up in negative risk sentiment on the RMB complex associated with the dollar move higher. Note that, a large chuck of the short USD forward positions accumulated late last year would likely mature into end of the year. Rolling over only a part of the overall stock, like in August/September, could well be the most expedient way of creating CNH tightness. Paying CNH curve steepeners could be a useful hedge to long risk portfolios into end of the year, targeting the 3M vs 12M spread back to recent highs of 1,200.”