Opinion Leader 丨 Guan Tao
In September, the positive gap between domestic foreign exchange supply and demand may expand again, which is contrary to the weakening of the exchange rate of the renminbi against the US dollar, but it will help to disperse the pressure of centralized settlement and reduce the annual closing effect of the imbalance between foreign exchange supply and demand and the fluctuation of the exchange rate. In the longer term, the RMB exchange rate to get rid of the simple linear relationship with the positive or negative correlation of the US dollar index is also the only way for the RMB exchange rate to form a more market-oriented.
In September, the dollar's exchange rate against major currencies fluctuated higher in the international market due to the impact of debt-buying expectations and the approaching US debt ceiling. By the end of the month, the Intercontinental Exchange (ICE) dollar index closed at 94.27, a new high in the past year. For the whole month, the dollar index rose cumulatively by 1.7%. During the same period, the midpoint of the renminbi against the US dollar fell by 0.3%, the second consecutive month of monthly decline in the median price (see Figure 1). This mainly reflects the explicit logic of "strong dollar, weak renminbi" implied in the mid-price quotation mechanism.
In September, the RMB exchange rate was weak and strong
The slowdown inflow of funds under cross-border securities investment has also become a bearish for the renminbi. In August, foreign investors netly increased their holdings of domestic RMB bonds by RMB8.4 billion, down 64.1% from the previous month, the second consecutive month of month-on-month decrease, and 91.7% lower than the average monthly net increase from June last year to June this year. This partly reflects the narrowing of domestic and foreign spreads and the weakening of the marginal attractiveness of RMB assets. In September, the yield spread between 10-year U.S. and Chinese government bonds averaged 149 basis points, down 5.0% from the previous month and 35.4% from December last year, and the momentum of overseas holdings of RENMINBI bonds is expected to slow further (see Figure 2). In addition, although the cumulative net purchases under the Mainland Stock Connect increased by 13.4% month-on-month in September, the cumulative net sales under the Hong Kong Stock Connect changed from the cumulative net sales in the previous two months to a net purchase of 15.5 billion yuan; the difference between the two, the cumulative net inflow of cross-border funds under the stock connect was 15 billion yuan, down 65.3% month-on-month (see Figure 3).
However, the RMB exchange rate in September was not actually weak. At the end of the month, the dollar index was near a new high in the year, but the middle price of the renminbi exchange rate closed at 6.4854, still up 1.3% from the low before the end of March; the closing price closed at 6.4626, up 1.7% from the low before the beginning of April. Throughout the month, although the median price of the RMB exchange rate fell slightly month-on-month, the closing price of the domestic interbank market at 4:30 p.m. (the same below) rose slightly by 0.03% month-on-month. In the month, the median value of the RMB exchange rate was 6.4599, up 0.3% month-on-month, ending the previous two consecutive declines; the average closing price was 6.4566, up 0.3% month-on-month, ending the previous three consecutive declines (see Figure 4).
At the end of the month, the China Foreign Exchange Trading Center Caliber (CFETS) renminbi exchange rate index closed at 99.64, the highest since early March 2016. During the month, the CFETS RMB exchange rate index rose by 1.0%, the third highest increase in the year (see Figure 5). This is mainly because, despite the decline in the exchange rate of the renminbi against the US dollar, of the 24 currencies traded in the interbank foreign exchange market (i.e. the China Foreign Exchange Trading Center system), the renminbi has appreciated to varying degrees against 19 of them, such as the euro, the Japanese yen, the british pound, the Australian dollar, the Korean won and the Thai baht, which rose by 1.4%, 1.5%, 2.2%, 1.3%, 1.4% and 4.2% respectively, with a total weight of 50.1% against the US dollar, Hong Kong dollar, dirham and Saudi riyal, which fell slightly by 0.3% against the US dollar, Hong Kong dollar, dirham and Saudi riyal. The russian ruble fell by only 1.0%, and the weights of these five currencies combined were 30.6% (see Figure 6). This year, the renminbi is the world's strongest currency. In the first three quarters, the us dollar index appreciated by 4.8%, the midpoint of the renminbi against the dollar rose by 0.6%, and the CFETS renminbi exchange rate index rose by 5.1% (see Figures 1 and 6).
Domestic foreign exchange or resupply exceeded demand in the current month
In August, the rmb against the US dollar at the time and the average monthly exchange rate both weakened, accompanied by a slight shortage of domestic foreign exchange supply (for details, see the September 27 "CbN Daily" column article "Increasing exchange rate flexibility is not just a matter of financial openness"). However, in September, the domestic foreign exchange situation may have reversed again.
In September, the closing price accounted for 65.0% of the trading day, an increase of 15 percentage points from the previous month. During the month, the mid-price fell by 175 basis points cumulatively, of which the closing price contributed 233 basis points to the stronger mid-price of the day, an increase of 173 basis points from the previous month, and a negative contribution to the weakening of the mid-price in the same period (see Figure 4).
Throughout the month, the average daily foreign exchange trading volume of the domestic interbank market spot inquiry was US$36.4 billion, up 7.4% month-on-month, ending the previous three consecutive declines. Among them, from September 16 to 29, the average daily foreign exchange trading volume was 43.4 billion US dollars, close to the peak of 43.9 billion US dollars per day in December last year (see Figure 7). This may mean that the gap between domestic foreign exchange supply and demand widened during the month. Considering that the RMB exchange rate is weak and strong in the same period, the high probability should be that the domestic foreign exchange supply exceeds demand again.
A number of factors contributed to the reversal of domestic foreign exchange supply and demand in the month
People may be confused about this. Why did the dollar index rise, the RMB exchange rate fell, and the gap between the domestic foreign exchange supply and demand widened? This may be explained from the following aspects.
First, while the dollar index hit a one-year high at the end of September, the average dollar index for the whole month was 92.98, up 0.2% from the previous month; the median was 92.79, down 0.1% from the previous month (see Figure 1). It can be seen that the strength of the dollar index so far is not obvious, which is not enough to make the market unanimously bearish on the renminbi. In fact, in September, the 1-year non-principal delivery forward (NDF) implied that the expected depreciation of the RMB exchange rate accounted for 63.6% (100% in the previous month), the lowest since June this year, and the average monthly depreciation was expected to be 0.1%, down 0.2 percentage points month-on-month and the lowest since June this year (see Figure 8). This shows that in the context of the strengthening of the US dollar, the expected rise and depreciation of the RMB exchange rate has alternated and the expectation is basically stable. Judging from the deviation of the offshore RMB exchange rate (CNH) relative to the onshore RMB exchange rate (CNY), CNH fluctuates up and down around CNY, with an average monthly deviation of only -2 basis points, down 10 basis points from the previous month, indicating that CNY's market credibility has further improved (see Figure 9).
Secondly, since the domestic US dollar liquidity is more abundant than that of the RMB, the quotation points of the RMB DOLLAR forward/swap for all major terms on the mainland in September have widened compared with the previous month. For example, the average long-term swap pips for 1-week, 1-month and 3-month periods expanded by 47.4%, 30.1% and 10.6% respectively, and the average swap pips for 6-month, 9-month and 1-year periods increased by 8.0%, 8.2% and 7.8% respectively (see Figure 10). According to the theory of interest rate parity, the forward exchange rate of high-interest currencies tends to depreciate. In view of the fact that the INTEREST RATE OF THE RMB is higher than the INTEREST RATE ON THE US DOLLAR, the expansion of the long-term swap point means that the discount rate of the RMB to the US dollar exchange rate of the corresponding period in the future (i.e. the depreciation of the RMB) will be expanded, which enhances the attractiveness of forward settlement, especially short-end forward settlement. Last month, banks bought US$15.2 billion in foreign exchange in advance in the spot market due to reduced net exposure to net settlement of foreign exchange in the spot market, offsetting a surplus of US$13.6 billion in spot settlement and sales, and the aggregate of bank forward (including options) settlement was US$1.6 billion (see Figure 7). In September, it is not excluded that banks will re-sell foreign exchange in advance in the spot market, further expanding the bank's foreign exchange settlement and sales surplus.
Third, the current basic balance of payments surplus is still relatively large, and the pressure of foreign exchange selling in the domestic market is further accumulated. In the first eight months, the "balance of international goods and services + non-financial FDI - non-financial OFDI" totaled US$319 billion, an increase of 38.7% over the same period of the previous year and an increase of 1.08 times over the same period in 2019 (see Figure 11). In the same period, the domestic foreign exchange deposits of financial institutions increased by US$66.3 billion, an increase of 1.71 times year-on-year, of which the foreign exchange deposits of non-financial enterprises increased by US$59.3 billion, an increase of 64.0% year-on-year (see Figure 12). In the second half of last year, the RMB exchange rate fluctuated and appreciated, and in order to avoid the exchange losses caused by the appreciation, the settlement of foreign exchange was postponed again and again, resulting in centralized settlement by the end of the year, resulting in a surplus of up to US$98.4 billion in bank forward (including options) settlement and sale in December last year, an increase of 3.93 times from the previous month, and the surplus hit a new high since the "8.11" exchange reform in 2015 (see Figure 7). Foreign exchange deposits of non-financial companies fell by $10.7 billion that month, ending a six-game streak (see Figure 12). This year, it is not excluded that even if domestic enterprises are bullish on the US dollar and bearish on the renminbi, in addition to increasing their own foreign exchange payments, they are also trying to reduce the pressure of centralized settlement at the end of the year by settling foreign exchange in batches.
In summary, despite the recent strong rebound of the US dollar index and the increased pressure on the correction of the RMB exchange rate against the US dollar, the strong foreign economic sector still supports the strength of the RMB's foreign currency value from the fundamentals. In September, the positive gap between domestic foreign exchange supply and demand may expand again, which is contrary to the weakening of the exchange rate of the renminbi against the US dollar, but it will help to disperse the pressure of centralized settlement and reduce the annual closing effect of the imbalance between foreign exchange supply and demand and the fluctuation of the exchange rate. In the longer term, the RMB exchange rate to get rid of the simple linear relationship with the positive or negative correlation of the US dollar index is also the only way for the RMB exchange rate to form a more market-oriented.
(About the author: Global Chief Economist of BOC Securities)