Chinese yuan’s surprise rebound unlikely to be sustained, say analysts
China’s yuan took the market by surprise at the beginning of 2017 with its biggest weekly gain ever amid tighter offshore liquidity and capital control measures, but analysts expect the rally to be temporary and anticipate more volatility for the currency in the year ahead.
During the first week of the new year, offshore yuan jumped 2.2 per cent against the US dollar and closed the week at 6.85, the largest weekly gain on record, driven by the surging offshore yuan (CNH) funding rate along with a weakened dollar index.
Hong Kong’s actual overnight offshore yuan borrowing costs at one point last Thursday shot up to above 110 per cent after the benchmark CNH Hibor was set at 38.33 per cent on that day. Yuan bears rushed into the market for CNH to square their short positions as short term expectations reversed.
The offshore rally also boosted onshore yuan, pushing it up to a short term high of 6.88 before both eased late Friday.
Credit Suisse analysts wrote in a note issued last Friday that the outlook of yuan against the US dollar “stays weak”.
“Chinese authorities stepped up efforts to limit the immediate weakness in both onshore and offshore yuan. However, there are lingering concerns about China’s persistent capital outflows, a contraction of the country’s currency reserve and growing corporate sector debt. We therefore believe that both the onshore and offshore yuan may well resume their weakening trend once this consolidation is over,” the note said.
Larry Hu and Jerry Peng, analysts with Macquarie Research, said the two important factors behind the movement of the yuan were the strengthening of the US dollar and capital outflow pressure faced by China.
Official data shows China’s foreign exchange (FX) reserves fell by US$41 billion to US$3.01 trillion by December. The total FX reserve decline for 2016 was US$320 billion, down from US$513 billion in 2015.
“Assume the change of the dollar this year is similar to last year (up 4 per cent), the game-changer is whether the PBOC could reduce capital outflows, either through capital controls or reversing the depreciation expectation,” the Macquarie analysts wrote in report issued Monday.
“Other than capital controls, to ease the one way depreciation expectation, the PBOC needs to increase the two-way volatility for the yuan. The sharp swing of yuan last week suggests that the PBOC is probably moving towards higher volatility for the currency,” the report said.
Aidan Yao, senior emerging Asia economist at AXA Investment Managers, said the goal of curbing capital outflows would be “fighting an uphill battle”.
Through measures such as tightening capital outflow channels, draining offshore yuan market liquidity, and revising the China Foreign Exchange Trade System (CFETS) calculation by reducing the weight of the US dollar, China has been doing a lot to stem the outflow speed, he said.
“But there is no guarantee that these efforts will pay off. As the dominant influence in FX is now from the US, Beijing is in a reactive position and fighting an uphill battle,” he said.
Meanwhile, the continuous defence of the yuan exchange rate has resulted in unintended negative side effects to China’s financial reform agenda, which includes making the yuan a more globally used currency and the bid to include domestic A-shares in globally traded indices.
Becky Liu, head of China macro strategy for Standard Chartered, said currency stability “has become a prerequisite for liquidity easing” in the offshore market, and she expects offshore yuan liquidity will likely stay tight in the first quarter of 2017.
Liu also sees another bearish year for the dim sum bond market – bonds issued outside of China, mainly in Hong Kong and denominated in yuan – after a tough year in 2016 amid the drained liquidity of offshore yuan.
“In 2017, we expect limited, if not slightly negative, capital gains from dim sum bonds. The total return in CNH terms is likely to be above 4 per cent again on interest accruals, while the USD return may stay positive on potentially slower FX depreciation,” she said in a report.
“We forecast a further decline of 34-41 per cent in primary issuance to 190-210 billion yuan.
“We expect CNH liquidity conditions to stay tight in the first quarter of 2017 amid sustained FX pressure due to firstly, a potential rise in capital outflows on the renewal of the US$50,000 retail conversion quota, despite tightening measures, and secondly a strong US dollar outlook, and thirdly, a possible rise in Sino-US trade tensions,” the report said.
Liu said she expected the overnight CNH Hibor to rise to 8-10 per cent in January from an average of 7.8 per cent in December 2016, and to remain high at 5-8 per cent for the rest of the first quarter.