China’s State Council meeting on 7 July opens the door for a possible targeted RRR cut in the near-term. Economists at HSBC believe the divergent monetary policy between China and the US has been a new normal. A narrower CNY yield advantage in 2021 is a key reason to expect USD/CNY to gradually be higher in the second half of the year.

A targeted RRR cut, if delivered, may not trigger significant CNY weakness

“This is the first time in more than a year since the State Council mentioned using RRR cuts as one of the monetary policy tools. In our economists’ view, this opens a door for a possible RRR cut in the coming months, if not weeks, and it is more likely that the cut is a targeted one with the aim of supporting small businesses. We also expect its impact on overall liquidity conditions and credit growth to be limited, while the People’s Bank of China’s (PBoC) policy stance is still to strike a balance between growth and leverage stabilisation.”

“A narrower CNY yield advantage in 2021 is a key reason behind our view that USD/CNY will gradually trade higher in 2H. However, the absolute yield advantage of the CNY is still high at the moment. Hence, if markets start to price in a more accommodative stance of the PBoC or when a (targeted) RRR cut is delivered, it may not trigger significant CNY weakness. Rather, it should serve to slow down the CNY's outperformance.”

“A higher USD/CNY has played into our thinking that the broad USD should begin to bottom in the months ahead. After all, the CNY’s performance is a key determinant of the broad USD overall. Our long-standing view has focused on the actual start of the Federal Reserve’s (Fed) tapering being supportive for the USD, especially those major central banks that could be expanding their balance sheets in contrast to the Fed or are having monetary policy shifting in a different direction.”

 

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