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RMB Bi-weekly - Improved fundamentals supports Yuan

 |  August 15, 2017

 Overview
• Yuan continues to outperform from USD weakness and improved fundamentals.
• Foreign ownership of Chinese assets increased to its highest amount in three years.
• Moderate growth is expected in Q3 with deleveraging initiatives in progress.


Yuan’s out-performance
CNH continues to outperform gaining another 2.2 percent against the USD since mid-July to 6.6580 on Aug 11. The onshore CNY market moved in parallel fashion by 2.35 percent to 6.6470 over the same period, although in recent sessions the basis or difference between the onshore versus offshore market have stretched to 120 points in favor of the CNY. During this time, the Dollar Index (DXY) lost -3.7 percent due to the erosion of investor confidence over Trump’s reform initiatives and softer US inflation data continued to undermine the greenback.

Meanwhile, USD weakness has been the catalyst for the Yuan’s strength as the resilience of the domestic economy has benefited the currency. China’s FX reserves expanded for the sixth consecutive month to $3.08 trillion in July with improved trade contributing to this growth. China’s major trading partners have been growing and with declines in Chinese imports, the trade balance stretched to $46.7B in July from a deficit of $9.15B in March.

As sentiment has become more positive for the Yuan, expectations for currency liberalization have risen. In recent months, various PBOC official and state news media have recommended that the CNY trading band be widened from +/- 2 percent to 3 percent. Given that the 2 percent edges around the band have barely been tested, its implementation should create very little risks or market disruption in the near term. This would allow the currency to fluctuate in a wider band and PBOC could scale back intervention efforts.


Foreign ownership of Chinese assets
Holdings of Chinese assets by foreign investors continue to gain momentum with the stability of the Yuan. According to People’s Bank of China (PBOC), onshore assets held by foreigners rose by 16% to CNY 3.76 trillion in Q2. Of the total, CNY deposits grew the most at +28%, followed by loans (+17%), equities (+12%) and bonds (+7%).

In Q2, foreign holdings in onshore bonds and equities formed new record highs. The robust pace may continue due to the constructive environment as concerns of outflows have diminished, the economic outlook for China remains positive and the Yuan continues to be stable. In addition, the introduction of China’s Bond Connect program in July and the inclusion of China into MSCI’s Emerging Markets Index should attract more inflows to the Middle Kingdom in the long term.


Moderate growth with deleveraging in progress
Financial deleveraging has been occurring and thus far we’ve seen a reduction in bank assets, issuance of wealth management products and assets under management by funds. However, more work needs to be done within the corporate sector especially with the high levels of leverage by State Owned Enterprises (SOE). As such, credit conditions could tighten further and Q3 may see some deceleration in growth versus Q2. This transition should be positively viewed compared to the alternative of systemic risks spreading and potentially lead the government to take drastic measures that may significantly impact growth.

In addition, the 19th National Congress of the Communist Party of China takes place this autumn. This event is held every 5 years and is closely watched as party delegates will elect the new leadership of the Communist Party and the Central Committee. Any major changes to economic policies or band widening are likely to take place after this important event.


Source: Reuters, Bloomberg

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About the Author

Market professional with over 20 years experience in FX and rates sales, trading and structuring. Provided coverage to clients in various business segments from corporates, Hedge funds, real estate investors and regional banks.
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