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Analysis On The Recent Fluctuation Of RMB Exchange Rate Depreciation

- Jul 03, 2018 -

From the perspective of economic data, the main reasons for the recent depreciation of the RMB exchange rate are as follows:

First, monetary policy in the us and Europe is divided, and the dollar index is expected to rise significantly. In June, the fed raised the federal reserve's benchmark interest rate by 25bps to 1.75-2.0%, the second rate increase of the year, and hinted at two more in 2018. The pace of interest rate rises exceeded expectations, prompting the dollar to appreciate. At the same time, the ECB has decided to keep its three main interest rates unchanged, leaving them unchanged at least through the summer of 2019, below market expectations. In contrast, the us and European "hawk pigeon", the dollar index appreciation expectations began to ferment.

Second, the sino-us trade war has led to a rise in global risk aversion and accelerated capital outflows from emerging market economies. According to data on global capital flows, global cross-border capital flows into the us from emerging economies net in May and June. Net flows into U.S. equity funds and bond funds in April were $-1.5 billion and $19.2 billion, respectively, according to EPFR data, compared with $26.11 billion and $5.38 billion in May. As of June 20, the figures were $13.85 billion and $1.25 billion, respectively. Situation in emerging markets, by contrast, April stock fund capital flows into emerging market countries and bond fund money flows of $11.77 billion and $1.73 billion, respectively, in May - $2.15 billion and $6.13 billion respectively. As of June 20, the figures were -6.75 billion dollars and -5.12 billion dollars.

Third, the relatively loose monetary policy of the central bank further increases the pressure on the depreciation of the RMB exchange rate. In 2018, under the overall stable macroeconomic situation, China's financial supervision was strengthened significantly, and non-standard financing contracted substantially. New social financing was halved in May, down 302.3 billion yuan from a year earlier. On June 24, in an effort to reduce financing costs for small and micro businesses, the central bank cut the reserve requirement in a targeted way, releasing 700 billion yuan of liquidity. On the one hand, structural loose monetary policy hedged the highly regulated credit contraction; on the other hand, it also increased the pressure on the depreciation of the RMB exchange rate.

This depreciation of the RMB exchange rate will not form a vicious circle of depreciation expectations - capital outflow. Unlike the "811" exchange rate reform, the central bank has not conducted quantitative intervention in the foreign exchange market, and the exchange rate depreciation has not triggered speculation and arbitrage in the foreign exchange market. Generally speaking, CNY has relatively more market control and CNH has relatively free trading. If there are depreciation expectations, investors can arbitrage in both markets. One of the most typical arbitrage methods is forward contract arbitrage through DF and NDF markets. When the offshore RMB forward rate depreciates more than the onshore RMB forward rate, traders can buy the DF forward contract in China and sell the NDF forward contract in the offshore market. After expiration, the us dollar purchased under the domestic DF forward contract can be sold in the overseas NDF market in exchange for more RMB. This type of arbitrage pattern became very popular after the reform of the "811" exchange rate. The central bank issued special policies to impose 20% risk reserves on forward foreign exchange sales and raise the cost of cross-border arbitrage. In June this year, the exchange rate difference between NDF and DF remained at about 400 basis points, significantly lower than the exchange rate difference of 1000 basis points after the "811" exchange rate reform. There was no arbitrage opportunity in the CNY and CNH markets.


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