The Renminbi is being manipulated, but Trump has it wrong: Chinese policymakers are helping stabilise the currency. The Renminbi is one of the least volatile global currencies as a result. Trump got China right…but for the wrong reasons. Chinese policymakers intervene in currency markets to keep the currency within a +/- 2% band from the close of the previous day’s closing rate. This process either generates foreign exchange reserves (if it sells Chinese currencies) or reduces reserves (if it supports the Renminbi). Foreign exchange reserves have fallen under the US$3tn level for the first time in six years, after peaking at US$3.99tn in June 2014. January’s US$12bn decline in foreign reserves could have been worse. Excluding valuation effects the decline would have been closer to US$40bn. The weakening of the Renminbi during 2016 prompted domestic investors and savers to look abroad in order to not lose purchasing power and boost investment returns in the face of the strong US Dollar. There are signs of a turnaround: the Renminbi has strengthened during 2017, likely assisting in reducing capital outflows. In addition to greater capital controls, the People’s Bank of China has increased rates on short-term repos for the first time since 2013, helping motivate more investors to keep currency in mainland China. The domestic outlook appears to be also helping, with our modified ‘Li Keqiang Index’ showing more stable growth in China over the past year. Estimates suggest that currency outflows have continued unabated since early 2015, totalling US$1.7tn over the period. Stemming the outflow of capital is a critical issue for Chinese authorities – a currency collapse could occur if China liberalises currency controls too fast, forcing the currency sharply lower and exacerbating capital outflows. Indeed, President Trump would be well served to improve Sino-US relations and support the Chinese efforts to stabilise its currency. With only the nascent signs of inflation appearing on a global level, a Chinese currency collapse could spark a new wave of global deflation, something the developed world does not need right now.
Martin Arnold, Global FX & Commodity Strategist at ETF Securities
Martin Arnoldjoined ETF Securities as a research analyst in 2009 and was promoted to Global FX & Commodity Strategist in 2014. Martin has a wealth of experience in strategy and economics with his most recent role formulating an FX strategy at an independent research consultancy. Martin has a strong background in macroeconomics and financial analysis – gained both at the Reserve Bank of Australia and in the private commercial banking sector – and experience covering a range of asset classes including equities and bonds. Martin holds a Bachelor of Economics from the University of New South Wales (Australia), a Master of Commerce from the University of Wollongong (Australia) and attained a Graduate Diploma of Applied Finance and Investment from the Securities Institute of Australia.
It is highly unlikely that President Elect Trump will officially deem China a currency manipulator when he takes office in 2017. China is a currency manipulator, but not in the way that Donald Trump thinks. The more than 6% decline in foreign exchange reserves in 2016 highlights that the Peoples Bank of China is supporting the currency rather than exacerbating its weakness to the detriment of American businesses, as Trump asserts. Falsely Trumpeting Chinese currency manipulation.
Chinese policymakers set a target rate for the Chinese Renminbi (CNY) each day, based on the prior day’s closing price, referencing a basket of currencies[1]. The currency is then able to trade within a +/-2% band on that day. China does intervene to manage the currency’s movements in order to ‘better maintain the overall stability of the RMB exchange rate’. Although the CNY has dropped nearly 3.4% against the US Dollar since end-Q2 2016, against its reference basket of currencies, it has fallen just 0.8%, broadly range-trading over the period.
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We expect that Trump will moderate the language he has used toward China and don’t expect him to label China a currency manipulator. The US Treasury have three criteria to determine whether a country is a manipulator. To be deemed a currency manipulator, a country must:
have a trade surplus of greater than US$20bn with the US (currently US$349bn[2]); and
have a current account surplus of greater than 3% of GDP (currently 2.4%[3]); and
be engaged in persistent one-sided intervention in the foreign exchange market by repeated net purchases of greater than 2% of GDP (China has net sales of 5% over past year[4]).
China currently only satisfies one of those criteria – that it has a trade surplus of over US$20bn with the US. President Elect Trump will have significant problems in changing the criteria or by naming China a manipulator if they do not satisfy all three.
We expect the move toward greater currency liberalisation to continue as there is an onus on China (with the CNY a part of the IMF SDR valuation basket) to increasingly have its currency determined by market forces to spur trade and investment activities. Labelling China a currency manipulator and instigating proceedings to punish its largest trading partner, would seem to be counter to Trump’s objective to generate greater business activity for US companies. If China continues, as we expect, to progress with further financial market reforms, it would make sense for the US to enhance ties with China to achieve greater access to Chinese markets for US companies.
[1] The CFETS RMB Index measures CNY against a basket of 13 currencies, based mainly on international trade. The largest weightings: USD 26.4%, EUR 21.4%, JPY 14.7%.
[2] Source: US Census Bureau
[3] Source: Bloomberg
[4] Source: Bloomberg
Martin Arnold, Global FX & Commodity Strategist at ETF Securities
Martin Arnold joined ETF Securities as a research analyst in 2009 and was promoted to Global FX & Commodity Strategist in 2014. Martin has a wealth of experience in strategy and economics with his most recent role formulating an FX strategy at an independent research consultancy. Martin has a strong background in macroeconomics and financial analysis – gained both at the Reserve Bank of Australia and in the private commercial banking sector – and experience covering a range of asset classes including equities and bonds. Martin holds a Bachelor of Economics from the University of New South Wales (Australia), a Master of Commerce from the University of Wollongong (Australia) and attained a Graduate Diploma of Applied Finance and Investment from the Securities Institute of Australia.
ETF Securities FX Research: Risk of a sharp CNY rebound
Risk of a sharp CNY rebound
Summary
Trending CNY weakness is not a surprise alongside a softer economic backdrop, central bank stimulus and portfolio outflows.
Debt concerns are not a global systemic issue, as foreign debt accounts for only 6% of the overall total and has been on a declining trend as of late.
CNY weakness and portfolio outflows are likely to reverse if Chinese equities are included in key global emerging market benchmarks.
Three benchmarks
The intention of the People’s Bank of China (PBOC), alongside further liberalisation of the currency, is to keep the valuation of the Renminbi ‘basically stable’ against a basket of global currencies. Risk of a sharp CNY rebound
Although the USD is the main currency that the market values the Chinese Renminbi (CNY) against, Chinese policymakers increasingly want to move the focus to a basket of currencies – the method they indicate they set the currency on a daily basis.
Officials state that the currency is allowed to deviate within a +/-2% band on a daily basis from the fixing rate which is partly determined by the closing value of the Renminbi on the prior trading day. Risk of a sharp CNY rebound
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In December 2015, the PBOC introduced the CFETS RMB Exchange Rate Index, to be more a representative valuation of the Chinese currency against its trading and investment partners. China Foreign Exchange Trade System (CFETS) is the foreign exchange markets subsidiary of the PBOC. There are 13 currencies in the CFETS basket, with the weightings largely trade based.
The other baskets that are referenced by Chinese officials are the IMF’s Special Drawing Rights (SDR) basket and the Bank of International Settlements (BIS) basket. The SDR is valued against the US Dollar, the Japanese Yen, the British Pound, the Euro and the Renminbi, while the BIS basket is valued against 40 different currencies. Regardless, the USD is the primary currency, with 26%, 42% and 18% weightings in the CFETS, SDR and BIS baskets respectively.
The recent onshore CNY weakness (against the USD) over the past two months doesn’t appear to be artificially distorted. Indeed, onshore traded Renminbi (CNY) moves in 2016 are in line with offshore traded Renminbi (CNH) movements. The gap between onshore and offshore markets that appeared during H2 2015 after the surprise CNY devaluation has all but disappeared, as the market becomes more comfortable with the more transparent CNY pricing.
No motivation for devaluation
If policymakers are devaluing the CNY the only motivation can be to boost trade. The benefits of currency weakness on trade is well documented. However, as the Chinese currency becomes more market-based, and most developed market central banks follow beggar-thy-neighbour stimulus to weaken local currencies, the gains to trade are likely be limited. Additionally with China sitting in the middle of many supply chains, the finished output to be exported could be more competitive as the currency depreciates. However, imported inputs to manufacturing would also be more expensive, limiting any strong benefits to devaluation from a trade perspective as well.
With so much focus and concern around China’s debt problems, the authorities are unlikely to want to exacerbate the problem by depreciating the currency, which would make the value of foreign debts larger in local currency terms. The fears are maybe overblown given that only 6% of China’s debts are denominated in foreign currency and are declining. However, given the nebulous benefits to trade from devaluation, increasing credit risks associated with devaluation (even though is small) does not appear worthwhile.
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There seems little motivation for policymakers to artificially weaken the Renminbi in the current environment.
Steady decline in FX reserves
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Currency weakness isn’t surprising for a country whose pace of growth is slowing, with a central bank in the process of cutting both the repo rate and the reserve requirement rate (RRR), and a government injecting other forms of stimulus. Calls for a stronger currency by foreign politicians are misplaced in such an environment.
Although the currency is officially managed against three benchmarks, the PBOC analyses its FX reserves in USD mainly. However, it has recently begun publishing foreign exchange reserves with the IMF’s SDR as the unit of account.
The PBOC is not actively devaluing the renminbi. Foreign exchange reserves are actually declining, a trend that could not occur if the PBOC were intervening in currency markets to devalue the local currency. Moreover, FX reserves have been in steady decline since mid 2014, after peaking at around US$4tn.
The recent weakness in the Renminbi has contributed to the trend decline in the outstanding level of foreign currency loans. If a loan is not hedged, a sustained decrease in the currency will lead to a greater debt burden. FX loans are likely to continue downward as the level of positive carry is expected to decline due to US rates increasing in coming years.
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June 14 deadline.
In addition to foreign debt, portfolio investment is critical to the direction of the CNY. Capital flows are likely to increasingly be a directional driver of the Chinese currency in the years ahead as liberalisation of the Renminbi gathers pace. Further currency weakness seems likely in the near term on this basis. Investment funds flowing out of China in Q1 2016, amounted to US$40.1bn, a 55% jump on a year earlier, according to the PBOC. In April, US$25bn of portfolio was withdrawn from Chinese assets, the 25th consecutive monthly outflows, according to the Institute of International Finance. Portfolio outflows can intensify as the decline in the CNY will have an adverse impact on foreign portfolio returns.
Nonetheless, the negative flows could abate quite quickly and even reverse in coming months. MSCI are expected to decide on June 14 whether to include Chinese A shares in its MSCI China Index (and consequently MSCI Emerging Markets Index). This is likely to prompt a lift of the CNY in the near-term as investment funds are redirected towards the country.
Liberalisation and beyond
Greater currency liberalisation is likely in the future, not only because of the greater scrutiny from the IMF (with the Renminbi now being in the SDR basket) but also as China seeks to gain greater interest in global commodity pricing dynamics. Currency transparency and flexibility are necessary to lure trading away from developed commodity trading platforms and encourage greater foreign participation on Chinese commodity exchanges. Although CNY weakness is warranted from an economic and portfolio flows perspective, the June 14 announcement of a potential inclusion of Chinese equities in key MSCI EM benchmarks could see recent CNY trends reversed. A greater degree of CNY volatility can also be expected alongside further liberalisation and transparency.
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This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”). The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities.
This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States. This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change.
Neither ETFS UK, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents. ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.
ETF Securities Currencies – Chinese Renminbi, The Basics
Summary
The liberalisation of currency controls and the growth of the “Dim-sum” bond market have seen the global trade of the hinese Renminbi (RMB) soar in recent years.
The RMB has come into sharp focus since last August, where its sudden depreciation generated a severe market selloff.
The RMB is traded on both onshore and offshore markets and rates between the two can differ.
Capital controls currently in place require the use of Non- Deliverable Forwards (NDFs) to gain exposure to the onshore RMB exchange rate for investors.
Since the development of the Yuan in 1948, Chinese authorities have maintained strict control over its value, pegging it to the US Dollar at various levels to meet economic objectives1. From 1994, the fixed exchange rate regime saw China accumulate a large trade surplus and considerable foreign exchange reserves (see Figure 1) as the undervaluation of the currency kept international exports artificially competitive.
(click to enlarge) 1 A Yuan is a unit of Chinese currency and is to the Renminbi (RMB) what the Pound is to Sterling, so both terms can be used interchangeably.
Unsurprisingly, this policy was unpopular and generated pressure from its primary trading partners, pressure which in 2005 led to a movement towards a “managed floating” exchange rate regime and a removal of the peg. This gave the currency more flexibility but still allowed for government influence on its overall level.
In more recent years, Chinese authorities have altered course and have progressively removed barriers to the free trade of the RMB. These moves have prompted the growing use of the Yuan in international business, with the RMB recently surpassing the Japanese Yen to become the fourth most popular payment currency globally (SWIFT, 2015). In addition, the proliferation of the “Dim-sum” bond market in 2009, which are bonds issued outside of China denominated in RMB have also helped the internationalisation of the currency. Global bodies like the International Monetary Fund (IMF) have also acknowledged the increasingly “free” use of the RMB and have included the Yuan in the valuation of its coveted Special Drawing Rights (SDR) basket in October of last year.
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Many faces of the RMB
The global market for the RMB is somewhat segmented and so is quoted in a number of forms.
The RMB is traded both on the onshore Chinese market and on numerous offshore markets in Hong Kong, London, Singapore and New York. On a daily basis the People’s Bank of China (PBoC), the Chinese Central bank, provides a daily fixing (at 09.15 local time) for the onshore rate (CNY) against the a basket of reference currencies, around which the pair can trade within a ±2% band. This onshore market, despite being somewhat liberalised, is still subject to considerable regulation.
The offshore market rate (CNH) is not subject to as strict controls and is ultimately determined by market forces. While the CNY and CNH rates tend to move in tandem, differences in liquidity and capital restrictions on arbitrage prevent this gap from closing permanently (see Figure 2).
Yuan plunges
On August 11th 2015, the PBoC announced that it would modify the mechanism through which the daily Yuan fixing would take place. In attempt to foster a more “market-driven” process, quotes from onshore primary dealers would be used as inputs into the calculation of the fix on a daily basis. That morning, the USD/CNY fix plunged 1.9% and the next day a further 1.0% in response, the largest absolute one day moves since the peg was removed in 2005.
The sharp declines sparked speculation that Chinese authorities were more concerned about domestic growth than previously anticipated and permitted the depreciation to boost the competitiveness of Chinese exports. The Chinese stock market reaction was sharp; with the Hang Seng Index plunging 3% intraday (see Figure 3). The impact was felt globally, with other major equity indices also falling considerably, only to recoup losses in the subsequent trade.
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How to trade the CNY
Due to trading restrictions imposed on the CNY, a liquid market for CNY Non-Deliverable Forwards (NDFs) has blossomed. An NDF is a forward contract that fixes the exchange rate for a currency transaction at some point in the future. At expiry the profit/loss of the underlying contract is calculated and converted into US Dollars and settled.
NDF’s evolved out of the necessity for market participants to hedge exposure to currencies such as the CNY, Taiwan Dollar (TWD) and the Brazilian Real (BRL) all of which are subject to capital controls and cannot be physically delivered. Like FX forwards, the rates at which NDFs price is based on expected future interest rate differentials between the two relevant currencies.
When using NDFs, an investor has to “roll” his/her position prior to expiry in order for the currency exposure to be maintained. “Rolling” involves closing out a near term position before it expires and re-investing in a longer dated forward. Like in other asset classes this process can incur a cost/gain depending on the shape of the forward curve. As mentioned previously, interest rate differentials determine forward FX levels and thus dictate the shape of the curve and the corresponding impact of the roll (see Figure 4).
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An alternative to investing through NDF’s directly is to utilise currency exchange traded products (ETPs). Currency ETPs provide a transparent, liquid and freely tradable medium through which to gain access to emerging market currency pairs. Currency ETPs trade like shares and mitigate some of the operational complexities involved in investing in NDFs, although indices are priced from NDF’s.
Prospects for the CNY
Chinese authorities continue to manage the nation’s transition from an export and investment led fast growing economy to a more moderate mature consumer driven model. Recent declines in the PBoC’s FX reserves and intervention in the onshore stock market reflect the government’s desire for stability during this period of change. Therefore the possibility of further monetary intervention remains, which, in the near term which could weigh the RMB.
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The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
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• Precious metals rally as industrial commodities slide on negative Chinese sentiment.
• European stocks sell-off as China reforms hit luxury goods and auto sectors.
• Chinese Renminbi devalued by nearly 5% as new reforms implemented.
The decision by the Peoples Bank of China (PBOC) to devalue its currency by a cumulative 5% last week, the most on record, and to change its fixing methodology for CNY caused a negative reaction across asset classes. Investors became more defensive, reducing positions in cyclical assets. Commodity sectors exposed to China, like energy and industrial metals, saw prices slide in a knee-jerk reaction as a result. USD weakness helped commodity markets rebound, as expectations of an interest rate hike began to be pushed further back in 2015. Many commodity prices initially declined by more than the change in the CNY/USD rate, indicating a sentiment driven change rather than a fundamental one.
Commodities
Precious metals rally as industrial commodities slide on negative Chinese sentiment. WTI and Brent crude oil benchmarks fell 5.47% and 2.47%, respectively reaching the lowest level in over six years, with the devaluation of the CNY thought by many investors to be a signal of declining future demand. Significant negative sentiment over the outlook for Chinese economic growth appears to be priced in to a range of commodity markets, particularly energy and industrial metals sectors. We expect the commodity price weakness to largely transitory many prices initially declining by more (in USD terms) than the devaluation of the CNY/USD rate, indicating a sentiment driven change rather than a fundamental one. Gold and silver were the largest beneficiaries of the China FX decision, as some risk aversion took hold as investor sentiment waned.
Equities
European stocks sell-off as China reforms hit luxury goods and auto sectors. European equity benchmarks posted losses early in the trading week, in line with other major global bourses, as investors digested the potentially negative implications of a weaker Renminbi for the Chinese economy. Sectors like materials, luxury goods and autos were some of the worst affected. The surprisingly weaker Q2 GDP numbers from Germany and France also adversely affected investor sentiment. In contrast, the Chinese sharemarkets didn’t overreact to the news as many other bourses did, posting gains for the week, despite weaker-than expected numbers on industrial production and retail sales.
Currencies
Chinese Renminbi devalued by nearly 5% as new reforms implemented. The significant policy change was to set the new Renminbi fixing rate at the previous day’s closing spot CNY rate. The PBOC’s move allows greater exchange rate flexibility and transparency of CNY pricing in its ongoing reform of the Renminbi and was not intended to be a ‘currency war’. We feel it shows progress towards a more market determined rate and is beneficial for its IMF SDR aspirations despite the IMF noting that the Chinese policy change has ‘no direct implications’ for its SDR review. Both the AUD and NZD lost ground on the markets expectations of more expensive exports to China crimping demand. Further softness from these two currencies is expected, with their respective central banks maintaining their easing biases. Meanwhile, the Swedish Krone was the strongest G10 performing G10 currency, after CPI numbers surprised to the upside which could keep the Riksbank from cutting rates at its next meeting.
For more information contact:
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
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This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (”ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (”FCA”).
Investments may go up or down in value and you may lose some or all of the amount invested. Past performance is not necessarily a guide to future performance. You should consult an independent investment adviser prior to making any investment in order to determine its suitability to your circumstances.
The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.
This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective, officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents.
ETFS UK is required by the FSA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.
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