The $48.9 billion reduction in U.S. bonds in the first quarter did not prevent the RMB exchange rate from falling.

Mars macroscopic

2024-05-27 06:00Published in Hunan Finance and Economics Creator

Executive Summary:

Since the beginning of this year, the exchange rate of the RMB against the US dollar has continued to decline. Selling the dollar, buying gold, issuing additional central bills, and expanding swap transactions, the central bank's four major moves to stabilize the exchange rate are becoming more and more difficult. The central bank's four major moves failed to hold 7.2, and the capital outflow that expanded month by month was the main factor driving the depreciation of the yuan. Under the control of the central bank's exchange rate stabilization operation and other exchange rate stabilization tools, the probability of the RMB exchange rate breaking through the previous key threshold of 7.35 is still very small.

1. Since the beginning of this year, the exchange rate of the RMB against the US dollar has continued to decline.

This round of RMB depreciation began in early 2023, and the stronger-than-expected resilience of the US economy drove the strengthening of the US dollar. Especially since August 2023, the pressure on RMB depreciation has increased significantly in the short term.

In the face of historically high interest rates, the labor market is hotter than expected, demand in the United States remains strong driven by rising wages, the economy is improving, and inflation is resilient, leading to the Fed's interest rate cut expectations from March, June to September, and continue to be delayed. This underpins the strength of the US dollar. On the RMB side, after more than two years of interest rate cuts, demand is still weak, oversupply has intensified, and prices have continued to fall. The downward pressure on the RMB is increasing.

The exchange rate of the renminbi against the US dollar fell from 7.0978 at the end of last year to 7.243 on May 26, a cumulative decline of 2%.

The central bank once made great efforts to stabilize the exchange rate of the renminbi against the US dollar within 7.2. It can be observed from the exchange rate chart that from January 16th to 22nd, the exchange rate accelerated downward, and when the opening broke through 7.2 on the 22nd, there were large US dollar sales for 2 consecutive days, suppressing the US dollar, pushing up the RMB exchange rate to 7.1439, a jump of 0.78% in one day.

From February 5 to March 6, the RMB has been hitting 7.2 against the US dollar, but the central bank has resolutely defended the market, and the bears have repeatedly failed to attack, and the 7.2 defense line seems to be impregnable.

However, starting from March 22, the power of the bears suddenly increased and broke through the 7.2 defense line in one fell swoop, so far, the central bank gave up the 7.2 exchange rate defense line and retreated to the 7.25 line defense. From the exchange rate chart, we can also observe that the central bank will protect the 7.25 line when the 7.25 line is in danger, and we have twice pushed the exchange rate from around 7.25 to around 7.2 from April 29 to May 16. However, the demand for the dollar was too strong, and the yuan was pushed to around 7.25 in a week.

Second, selling the dollar, buying gold, issuing additional central bills, and expanding swap transactions, the central bank's four major moves to stabilize the exchange rate are becoming more and more difficult.

From August 2023 to February 2024, the U.S. dollar index fluctuated sharply between 101-107, but the RMB exchange rate remained relatively stable, especially in August and November last year and January-February this year, the RMB exchange rate fluctuated sideways in a narrow range of around 7.3 and 7.2 respectively. Behind the "decoupling" of the exchange rate trend and the dollar index trend, it should be that the central bank has strengthened the management of the exchange rate.

The first is to sell US bonds.

Selling U.S. bonds for U.S. dollars and then selling U.S. dollars to buy renminbi has been one of the central bank's main means of stabilizing the exchange rate.

According to the U.S. Treasury Department's monthly data on global foreign holdings of U.S. bonds. Although the mainland is still the second largest holder of US bonds, we have been reducing our holdings of US bonds to a greater or lesser extent. It reduced its holdings by $7.6 billion in March, the third consecutive month of reducing its holdings of U.S. Treasuries since January. In the first quarter, the cumulative reduction of U.S. bonds was 48.9 billion US dollars. At the end of March, the total amount of U.S. debt held was $767.4 billion, a decrease of $101.5 billion, or 11.7 percent, from $868.9 billion in the same period last year.

In December 2012, China increased its holdings of U.S. bonds by $19.7 billion that month, and its total holdings exceeded the 1.2 trillion mark to reach $1.2028 trillion, a record high. As of the end of March 2024, we have reduced our holdings of U.S. bonds by a cumulative $435.4 billion, and our holdings of U.S. bonds have decreased by 36.2% over the past 11 years.

As of March 31, 2024, the balance of U.S. Treasury bonds has also reached $34.5 trillion. We hold 2.22% of U.S. Treasuries.

The second is to increase holdings of gold.

Gold is probably the only liquid asset that is not bound by certain creditor relationships, and it is independent of governments and is an asset that is widely accepted and recognized in various countries. Due to its unique properties, gold can be one of the few means of risk hedging.

According to a survey by the World Gold Council, factors such as global central banks entering a monetary easing cycle, rising debts of major countries, and global geopolitical disturbances have driven the gold price pivot to continue to rise, and central banks have generally increased their holdings of gold to stabilize the value of their local currencies.

In the first quarter of 2024, global official gold reserves increased by 290t, of which the Chinese Bank bought 27t in the first quarter and increased its holdings by 1.866t in April. China's central bank has increased its gold holdings for 18 consecutive months, making it the country with the largest holdings in the past year. However, the growth rate of mainland gold reserves began to narrow in April, which was the lowest value in nearly 18 months.

The increase in the importance of gold in the mainland's foreign exchange reserves reflects the PBOC's firm determination to optimize the structure of foreign exchange reserves, enhance asset security, and support the stability of the RMB exchange rate.

The third is to issue additional central bank bills in the Hong Kong market and break the arbitrage trade by raising the offshore RMB interest rate.

In addition to reducing holdings of U.S. bonds, increasing holdings of gold, and increasing control over foreign exchange purchases, the central bank's operation to stabilize the exchange rate has taken on new characteristics. What is different from the past is that in this round of the central bank, in addition to playing the open card of depleting official foreign reserves and increasing gold purchases, it has also adopted more covert hidden tactics to maintain exchange rate stability.

There are a large number of "RMB-USD" arbitrage transactions in the Hong Kong market, that is, the liability side borrows low-interest RMB, and the asset side buys high-interest US dollars. Once the interest rate differential between the offshore RMB and the US dollar narrows, the arbitrage space will be compressed, and the arbitrage trade will be reversed, thereby supporting the stabilization of the offshore RMB exchange rate. The central bank mainly recycles RMB liquidity through the issuance of additional offshore high-yield central bank bills in the Hong Kong market, which is one of the hidden tricks.

For example, from July to October 2023, the PBOC issued an additional 40 billion yuan of offshore central bills compared with the same period in 2022, and the interest rate differential with the US dollar narrowed significantly, making the offshore RMB interest rate rise to about 5% from August to September 2023.

Fourth, currency swap transactions were carried out with major banks in the domestic market to stabilize the exchange rate.

Sell US dollars and buy RMB in the spot market to support the RMB exchange rate.

Since the beginning of this year, the central bank has carried out a number of currency swap transactions with major banks, and its operation path is that the central bank and major banks have signed currency swap agreements to put US dollars and withdraw RMB in the spot market, so as to support the RMB exchange rate, and put RMB and withdraw US dollars in the forward market. From August to November last year, the "other liabilities" of the central bank's balance sheet increased by 478.9 billion yuan, the highest value in the same period in history and 241.2 billion yuan higher than the average of the previous five years. The increase may be due to currency swaps.

3. The central bank's four major moves failed to hold 7.2, and the capital outflow that expanded month by month was the main factor driving the depreciation of the RMB.

Due to the weakness of the domestic economy and the uncertain trajectory of the Federal Reserve's interest rate, the mainland has seen a continuous capital outflow since July last year, and the outflow has intensified since the beginning of this year, constituting an unfavorable factor for the renminbi.

According to official data released by the State Administration of Foreign Exchange, local businesses and residents bought the largest amount of foreign exchange from banks since 2016 in April, while exporters postponed the exchange of dollars. This led to a surge in capital outflows in April to the highest level since 2016.

In April, commercial banks sold $211.8 billion in foreign exchange to customers, but corporates sold only $173.7 billion to banks, resulting in a net foreign exchange outflow of $38 billion, the highest since December 2016. Previously, there was a net foreign exchange outflow of $9.9 billion in January, a net inflow of $1.7 billion during the Spring Festival in February, and a net outflow of $16.6 billion in March.

Since 2022, the net foreign exchange settlement and sales of banks have been highly negatively correlated with the change in the RMB and US dollar exchange rates. It can be seen that the deficit in foreign exchange settlement and sales, which has been expanding month by month since the beginning of this year, is the main reason for the increasing downward pressure on the RMB exchange rate against the US dollar.

Persistent foreign exchange outflows are rare because exporters are more inclined to hold foreign exchange than to buy foreign currency in renminbi given weak economic growth expectations and continued capital outflows. As a result, although we have enjoyed an export surplus for a long time, exporters' willingness to exchange foreign exchange has been sluggish, and the net settlement and sale of foreign exchange for trade in goods has decreased from $30.5 billion at the end of last year to negative $2.3 billion in April.

Second, the net outflow of foreign exchange settlement and sales of trade in services continued to expand. In terms of trade in services, the deficit in services related to outbound tourism rebounded significantly, resulting in a deficit in foreign exchange settlement and sales of trade in services, which widened from US$17.9 billion in January to US$22.4 billion in April.

Third, the inflow of direct investment has decreased, and the outflow of direct investment has expanded. In April, banks sent a record $29.5 billion in net remittances overseas for direct investment on behalf of their customers.

These factors indicate a cautious view of the RMB in the market, as our relatively low interest rates with the US are in favour of the US dollar. While the People's Bank of China (PBoC) has stepped in to keep the renminbi in a tight range, uncertainty over the timing and magnitude of the Fed's rate cuts this year has made its job more difficult.

Considering the domestic and foreign macro fundamentals and the changes in the monetary policies of China and the United States, we believe that the downward pressure on the strong US dollar and RMB will continue throughout the year. However, due to the above-mentioned central bank's exchange rate stabilization operations and other exchange rate stabilization tools, even in the second and third quarters under the background of the US dollar maintaining a strong operation, the probability of the RMB exchange rate breaking through the previous key mark of 7.35 is still very small.

Given the rising capital outflow pressures, we expect policymakers to maintain tight controls through strong RMB pricing and offshore liquidity management to hedge against depreciation expectations.

[Author: Xu Sanlang]

View original image 97K

• 

• 

• 

• 

• 

Personal opinion, for reference only