The motivation behind a higher USD/RMB fix
Published time：[13 Aug, 2015 12:10] From：E Fund Management (HK) Co., Limited
The motivation behind a higher USD/RMB fix
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Reasons for RMB Devaluation：There are two major objectives. 1) To cause RMB currency more dynamic to reflect the true demand-supply equilibrium of market, which will be beneficial for RMB to be part of SDR in the future (IMF considers RMB is far from required standard of SDR in terms of free convertibility and indication of market demand); 2) To stimulate export and domestic economy (recent data of import-export is lower than expected). Foreign investors predicate RMB will depreciate after the crash of China stock market. Therefore, RMB’s hedging cost is trending up. RMB devaluation is a natural response to the market, thus can be seen as market driven, which reduces the political pressure from US.
Impact on Bond Market：The two days consecutive depreciation of RMB fixing
rate has caused negative impact on bond market. On one hand, bond market has
experienced a huge rise in previous days and yields are comparatively low. Bond
market therefore is under downward correction pressure. On the other hand, RMB
devaluation has created a shock to the market due to worries of tight liquidity
resulting from capital outflow. Because of currency control, capital
displacement is under control. The direction of bond market is largely
depending on the domestic demand and supply. Previously, we were very cautious
on being bullish on bond market, because we believe US-China interest rate
discrepancy cannot keep shrinking under that high RMB valuation. Now, RMB
devaluation has created room for more aggressive monetary policy, and has also
created room for interest rates to drop in the future. At present, China is
facing pressure to stabilize economy, and it is expected to keep monetary
policy loose. Besides, risk appetite of market capital for wealth management
products (large in volume and allocated in IPO previously) has changed after
the stock market crash. Low risk asset like bonds are more welcomed and chased
by the market. In general, we think it is a right time to purchase bond after
the shock of currency. Because we have already factored RMB depreciation in the
management of our portfolio, we keep the portfolio duration at a low level.
Therefore, the impact of RMB depreciation to our portfolio is limited.
Monetary Policy：Due to the fact that PBoC will need to inject huge
liquidity to offset the outflow of capital, we believe the decrease of RRR is
mandatory measure in parallel.
Exchange rate trend：Our estimation is that PBOC will complete the devaluation process promptly as a one-time adjustment, instead as a gradual process. This view can be supported by today’s positioning of the RMB mid-price, which is between yesterday’s CNH and CNY’s closing mid-price. In the past, investors’ evaluate RMB based on the assumption that PBOC would maintain a stable rate against USD (which was true in the past); however, once the assumption is overthrown, PBOC will be facing very limited options in terms of exchange rate. If PBOC stops the devaluation before the market balance point or attempts to stabilize market expectation, the result will be an increase of capital outflow as the market will expect another devaluation shock given the economics pressure China currently faces. A gradual devaluation process may then magnifies the unfavorable outcome induced by the devaluation. On the other hand, a one-time devaluation, given the RMB is, in fact, being overestimated, minimized the time period of the inevitable process. Although cost may be induced by intervening the market, the capital outflow can be better contained. A one-time, effective devaluation is beneficial in term of capital stability. Exchange rate will reach equilibrium at minimal cost. The time frame for this process, according to our expectation, will be around 2-3 business days.
Actions for current investors：We think that it is too late to cut losses merely by fund redemptions. By the time of cash settlement (usually takes 5 business days), the devaluation will already be completed. Institutions may lock up the currency risk to prevent another drop of exchange rate.
The value of mid-long term RMB investment：Looking at the medium to long term, we, in fact, welcome the marketization of the RMB exchange rate. Marketization will improve liquidity of offshore RMB and the pricing mechanism as a whole. The increase market divergence will lower the impact of a policy Black Swan. RMB will also experience a shift in its role from a substitute of USD to a currency option for investment diversification.
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