Source: Pinglan Guantao
Authors: Guan Tao (Global Chief Economist of Bank of China Securities) and Liu Lipin Analyst
The research report was released on December 18, 2023
Summary
In November, the RMB exchange rate rebounded due to the easing of Fed tightening expectations and the pullback in the US dollar index and US Treasury yields due to the unexpected decline in US CPI in October, and the volume of interbank spot inquiries also rebounded significantly.
In November, the number of "foreign exchange purchases on dips" by market players increased, and the foreign exchange settlement and sales of banks, namely forwards (including options), continued to run deficits since July, and the scale of the deficit expanded month-on-month. In this context, the Central Economic Work Conference has emphasized "maintaining the basic stability of the RMB exchange rate at a reasonable and balanced level" for two consecutive years, while the Central Economic Work Conference in previous years only emphasized this expression in 2016 and 2017.
Under the circumstance that the RMB exchange rate stopped falling and rebounded, the demand for forward foreign exchange settlement of market entities increased, but the willingness to settle foreign exchange at spot hit a new low in the same period in recent years. The subsequent trend of the RMB exchange rate may be supported by the release of foreign exchange settlement demand, but it still mainly depends on the economic and policy direction of China and the United States.
Since 2017, the RMB has basically appreciated from November to January of the following year, showing a strong seasonal pattern, but the weakening of the US dollar is an important driving factor, and from the perspective of the settlement of foreign exchange around the Spring Festival in each year, the impact of the "foreign exchange settlement tide" on the RMB exchange rate should not be exaggerated.
In November, the willingness of foreign investors to allocate RMB bonds increased significantly, with a net inflow of 251.3 billion yuan under Bond Connect, with interbank certificates of deposit and treasury bonds being the main contributors, and the net outflow of funds under Mainland-Hong Kong Stock Connect narrowed significantly to 1.8 billion yuan, and the overall net inflow of foreign capital under securities investment recovered.
Risk Warning: Overseas financial risks exceed expectations, major central banks adjust monetary policies more than expected, and domestic economic recovery is not as expected
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On December 15, the State Administration of Foreign Exchange (SAFE) released its foreign exchange receipts and expenditures for November 2023. Combined with the latest data, the operation of the domestic foreign exchange market in November is analyzed as follows:
The U.S. dollar index fell, and the volume and price of the domestic foreign exchange market rose
In November, the central parity of the RMB rose to around 7.10, and the spot exchange rate rose back to within 7.20 due to the easing of Fed tightening expectations and the pullback of the US dollar index and US Treasury yields due to the unexpected decline in US CPI in October. During the period, the U.S. dollar index fell from around 107 to 103, a cumulative decline of 3.0%, while the spot exchange rate of the onshore renminbi (the onshore interbank market closed at 4:30 p.m., the same below) rose 2.6% (see Chart 1). As major non-US currencies rose more than the RMB, the China Foreign Exchange Trade System (CFETS) RMB Exchange Rate Index, the RMB Exchange Rate Index of the reference BIS and the SDR currency basket continued to retreat, falling by 1.0%, 1.1% and 0.4% respectively in November (see Charts 2 and 3).
From November 1 to 17, the median price was basically stable around 7.17~7.18, and the average daily fluctuation range was only 4 basis points. On November 20, the median price of the next day showed a pullback of hundreds of basis points, rising from below 7.16 to around 7.10 at the end of the month, with a cumulative appreciation of 1.0%, and the deviation of the spot exchange rate from the central price in the same period was within 0.5%, and the average expected depreciation of the RMB exchange rate implied by the one-year NDF was 0.4%, 1.1 percentage points narrower than the average from November 1 to 17 (see Charts 4 and 5). The rebound of the RMB exchange rate has been active in the foreign exchange market, and the volume of interbank spot inquiries has rebounded significantly, rising to US$34.7 billion on November 20 (the day the mid-rate jumped), and the average daily volume of the month was US$23.2 billion, an increase of 74% month-on-month (see Chart 6).
The demand for foreign exchange purchases in the market has driven the negative gap between domestic foreign exchange supply and demand to widen, and the Central Economic Work Conference has reaffirmed the stability of the exchange rate
In November, the deficit of foreign-related receipts and payments of banks on behalf of customers continued to decline in the previous month, from US$18.5 billion to US$1.2 billion. In terms of sub-items, the surplus of foreign-related receipts and payments for trade in goods narrowed by US$8.4 billion month-on-month to US$26.7 billion, but the deficit in portfolio investment turned to a surplus of US$13.1 billion from the previous four consecutive months, contributing 140% of the month-on-month decline in the deficit of foreign-related receipts and payments of banks on behalf of customers (see Chart 7). In terms of currency, the renminbi's foreign-related receipts and payments deficit narrowed to US$6.3 billion for six consecutive months, while the foreign currency surplus fell to US$5 billion from US$8.8 billion in the previous month (see Chart 8).
In the same month, the average monthly onshore spot exchange rate of RMB was 7.2269 to 1, ending the "six consecutive declines" and rising 1.1% month-on-month. During the same period, the exchange rate after excluding the forward performance amount fell by 1.6 percentage points month-on-month to 50.3%, but the exchange rate for foreign exchange payments increased by 1.3 percentage points to 64.0%, ranking the third highest since 2017 (see Chart 9), reflecting the increase in "bargain purchases" by market players in the context of RMB appreciation.
In November, the foreign exchange settlement and sale of forward (including options) of banks, which reflects the foreign exchange trading relationship between domestic banks and customers, continued to be in deficit since July, and the scale of the deficit widened from 18.8 billion yuan in the previous month to 24.9 billion US dollars. Among them, the deficit of spot foreign exchange settlement and sales increased from 7.5 billion yuan in the previous month to 24.6 billion US dollars, mainly due to the increase in the deficit of foreign exchange settlement and sales of banks on behalf of customers from 8.1 billion yuan in the previous month to 23.3 billion US dollars, a new high since 2017, contributing 247% of the increase in the aggregate deficit of bank settlement and sales The bank's own foreign exchange settlement and sales turned from a surplus of US$500 million to a deficit of US$1.4 billion, the cumulative unexpired amount of forward net foreign exchange settlement increased by US$4.4 billion from a decrease of US$5.4 billion in the previous month, and the net foreign exchange settlement of delta exposure of unexpired options narrowed from US$5.8 billion in the previous month to US$4.7 billion, and the total bank foreign exchange derivatives trading exposure increased by US$10.9 billion month-on-month (see Chart 10).
The recent 2023 Central Economic Work Conference emphasized "maintaining the basic stability of the RMB exchange rate at a reasonable and balanced level", which is consistent with the 2022 statement, which was only emphasized in 2016 and 2017 in previous years. In the past four years, except for the successful counterattack of the RMB exchange rate in 2017, the RMB spot exchange rate has fluctuated greatly in 2016, 2022 and 2023, with the maximum amplitudes of 7.7%, 16.0% and 9.4% respectively (see Chart 11).
The demand for forward foreign exchange settlement of market entities has increased, but the willingness to settle foreign exchange at spot has hit a new low in the same period in recent years
In November, the average 1-year RMBUSD forward swap narrowed by 59 bps month-on-month to -2610bp, indicating an increase in the financial attractiveness of forward settlements (see Chart 12). In the same month, the contract value of forward foreign exchange settlement was US$26.4 billion, an increase of US$10.4 billion month-on-month, and the forward foreign exchange settlement hedging ratio increased by 3.0 percentage points month-on-month to 9.3%, reflecting the increased efforts of market entities signing forward foreign exchange settlement contracts to guard against the risk of future RMB appreciation as the RMB exchange rate stopped falling and rebounded (see Chart 13).
Since July 2023, the exchange rate of foreign exchange settlement, measured by the proportion of foreign exchange settlement of trade in goods to foreign-related income, has been significantly lower than the same period in previous years (except for August only), and the exchange rate of foreign exchange settlement has fallen to 47.3% in November, the lowest since March 2019 (see Chart 14). During this period, the overall willingness of the market to settle foreign exchange in July, September and November was also the lowest since 2018 (see Chart 9).
In addition to the increase in the proportion of RMB settlement in trade in goods has reduced traders' demand for foreign exchange settlement (see Chart 15), the low exchange rate reflects that traders have a stronger incentive to postpone foreign exchange settlement in the context of the pressure on the RMB exchange rate in the previous period. The subsequent trend of the RMB exchange rate may be supported by the release of traders' demand for foreign exchange settlement, but it still mainly depends on the economic and policy trends of China and the United States.
The impact of the "foreign exchange settlement tide" on the RMB exchange rate before and after the Spring Festival should not be exaggerated
For example, from November to January of each year since 2017, the RMB exchange rate has basically appreciated while the US dollar index has risen and fallen (see Chart 16). The market usually attributes this to the "foreign exchange settlement tide", that is, before the Spring Festival, enterprises to pay salaries, bonuses and other needs to settle a large amount of foreign exchange. Is that really the case?
As of January 2023, 17 of the 18 months from November to January 2017 have been appreciating. Among them, there were 11 months when the US dollar weakened and the RMB strengthened, such as in November 2023, indicating that the weakening of the US dollar is an important factor driving the appreciation of the RMB. In the other 6 months, the US dollar and the RMB rose together, especially in January 2021, when the RMB exchange rate rose by 1.2%, which was greater than the US dollar index's increase of 0.6%, and the peak of foreign exchange settlement before the Spring Festival in 2021 was advanced to December 2020. In December 2020, the exchange rate of foreign exchange collection and settlement by banks excluding forward performance was 70.6%, up 8.3 percentage points from the previous month, while the exchange rate of banks excluding forward performance was 60.8%, up 8.6 percentage points from the previous month (see Charts 16 and 17).
In addition, judging from the exchange rate of foreign exchange settlement before and after the Spring Festival every year since 2018, the peak of foreign exchange settlement before and after the Spring Festival in each year (not the peak of foreign exchange settlement throughout the year, the same below) is concentrated from December to February of the previous year. Among them, 2018 appeared in February of the same year, 2019 and 2020 appeared in January of the same year, 2021 was advanced to December of the previous year, 2022 appeared in December of the previous year and January of the same year, and 2023 was postponed to February after the holiday (see Chart 17). On the contrary, the appreciation of the renminbi in November of each year does not correspond to the peak of foreign exchange settlement.
The willingness of foreign investors to allocate RMB bonds has increased significantly, and the net inflow of foreign capital under portfolio investment has generally recovered
In November, there was a net inflow of funds under Bond Connect (northbound) for three consecutive months, and the scale of net inflows increased month by month, with 17.8 billion, 42.2 billion and 251.3 billion yuan respectively, and the net increase in holdings in November was the second highest in history. According to the data of the Shanghai Clearing Exchange, the net increase in holdings of foreign institutions increased from 4.9 billion yuan in the previous month to 94 billion yuan, of which interbank certificates of deposit were the main contributors, and the net increase in holdings of foreign institutions rose from 5.8 billion yuan in the previous month to 86.8 billion yuan, which is related to the recent inversion of the interest rate on certificates of deposit and MLF interest rates. Historically, the 1-year interbank CD interest rate is usually capped at the 1-year MLF interest rate, but since mid-October, the tightening of bank funds has pushed the CD interest rate upward, and the average monthly interest rate spread between the MLF interest rate and the CD interest rate has widened from -2.1BP in the previous month to -9.4BP, and the CD allocation is more cost-effective. According to the data of China Bond Deng, foreign institutions have increased their net holdings for two consecutive months, and the scale of net holdings has risen from 37.3 billion yuan in the previous month to 157.3 billion yuan, and the net increase in the inversion of the interest rate gap between China and the United States (the average monthly 10-year US bond yield spread has decreased from -211BP to -184BP) and the increase in favorable factors for China's economic development, the demand for foreign capital allocation has increased, and the net increase in the scale of government bonds has risen from 12.4 billion yuan in the previous month to 112.8 billion yuan, and the net increase in policy bank bonds has risen from 29.2 billion yuan to 49.5 billion yuan (see Charts 18, 19, 20）。
In November, the scale of net outflow of funds under the Mainland-Hong Kong Stock Connect (northbound) narrowed sharply to 1.8 billion yuan, while the average net outflow from August to October was 57.3 billion yuan, and 12 of the 22 trading days of the month were net outflows, and the proportion of net outflow trading days dropped from 81% in the previous month to 55%. In the same month, the net inflow of funds under the Hong Kong Stock Connect (Southbound) continued to decrease, from 21.4 billion yuan in the previous month to 17.1 billion yuan, and after the difference was offset by the cumulative net buying turnover of the Stock Connect, the net outflow of funds under the Stock Connect was 18.9 billion yuan, narrowing for three consecutive months (see Chart 21).
In November, the combined net outflow of foreign capital from 2.6 billion yuan in the previous month turned into a net inflow of 249.5 billion yuan. In the same month, the foreign-related receipts and payments of securities investment turned into a surplus of US$13.1 billion from the previous four consecutive months, and the foreign exchange settlement and sales of securities investment continued to be in deficit but narrowed by US$1.4 billion from the previous month to US$5.8 billion.
Risk Warning: Overseas financial risks exceed expectations, major central banks adjust monetary policies more than expected, and domestic economic recovery is not as expected.