While China’s PBOC today fixed the yuan stronger against the US dollar for the first time this week, it does not mean the weakening trend is over.
According to Ray Farris and Trang Thuy Le, FX strategists at Credit Suisse, the USD/CNY exchange rate is headed towards 6.6000 over the next three months, some 3.10% above its current trading level, leaving the yuan weaker.
On Thursday’s PBOC press conference, where the bank declared there was no need for the yuan to weaken further, the pair note that the language used, while vague, suggests it’s actually still looking for the opposite.
“PBOC officials have described the adjustment weaker in the CNY as ‘almost completed’ as well as ‘basically already completed’. Vague and contradictory as always, but we read them as saying they want a bit more adjustment weaker in the CNY on a basket basis, but not a lot,” they note.
Farris and Le also find further hints the bank is willing to see the yuan drop.
“The final paragraph of the PBOC’s statement today refers to USD strength in market expectation of FOMC rate hikes. We read the text as indicating that the PBOC will allow a strong USD trend to flow through into USD/CNY to some extent,” they note.
Beyond US dollar strength, Farris and Le believe weakness in China’s economy, the prospect for further monetary easing from the PBOC and China’s anti-corruption campaign suggest the yuan should remain cyclically weak.
While the pair are on the more aggressive side of expectations for further yuan depreciation – something they freely admit – they suggest there are three possible scenarios that could derail their call: the PBOC managing the yuan rate more heavily than they expect, a delay in monetary policy tightening in the US and an unexpected recovery in China’s economic fortunes.
Here’s their view.
“Three main risks to our forecasts stand out.
First, the PBOC may manage the CNY more heavily than we expect, preventing USDCNY from rising much about 6.50. Perhaps, but this would imply the CNY appreciating on a TWI basis back to levels that led the government to weaken it in early March and again this week (Exhibit 1) To be sure, the PBOC’s commentary so far suggests that much of the motivation for the recent devaluation was excessive CNY TWI appreciation.
Second, the Fed could delay rate hikes, stalling the broad USD rally we expect or possibly reversing it somewhat. We think this is unlikely given the persistent strength of the US labor market.
Third, Chinese economic growth could recover more strongly than we expect, eliminating the need for further PBOC monetary easing and stimulating flows into Chinese assets. The recently announced additional 1tn yuan in funding for infrastructure over three years, about 0.2% of GDP at face value and 0.4%-0.6% assuming substantial multipliers, seems too small to generate a powerful growth recovery. As indicators of sustained recovery, we think growth in total social”.
Today the USD/CNY sits at 6.3990, the same as Thursday’s closing level.