Why investors are shrugging off the yuan’s recent depreciation
Unlike the previous periods of yuan depreciation, the recent slide in the currency has been met with relative calm in the markets
The yuan has been volatile in the past month, and the Chinese central bank looks inclined to guide the currency weaker. But markets have so far reacted quite calmly towards the depreciation, a sign that investors may have become more accepting of the yuan’s gradual slide, analysts said.
The yuan fell to its lowest level in one and half years on Monday against a trade-weighted basket, after the People’s Bank of China (PBOC) strengthened the yuan’s reference rate by less than expected versus the dollar, suggesting that the authority still has a weakening bias, according to data from Bloomberg. The US dollar tumbled to a three-week low on Friday, after the May nonfarm payroll report showed the US economy added the fewest jobs since September 2010.
For May, the yuan fell 1.5 per cent against the US dollar in the onshore market, the largest monthly depreciation since last August.
“[However] the street is not yet concerned about CNY [Chinese yuan] depreciation,” said Larry Hu and Jerry Peng, analysts for Macquarie Securities, in a note on Monday. They added that the market response has been relatively “calm” compared with January and August.
On January 7, the PBOC lowered the daily yuan fixing versus the US dollar by 332 basis points, the biggest cut in four years. At the time, the abrupt depreciation triggered heavy selling in the Chinese equity market and sparked further selling in the currency. In the first two weeks of trading in January, the yuan slid 1.4 per cent against the US dollar in the onshore market.
Back on August 11, the central bank devalued the yuan by 1.9 per cent, rattling global financial markets and triggering selling in risk assets.
But this time, investors “are cautious in shorting RMB”, as things have changed compared to January and August, Macquarie analysts said.
First of all, the PBOC’s daily fixing setting has become more “rule-based” and “transparent” -- based on the closing on the previous day and a basket of currencies.
“As such, the markets could interpret the latest CNY depreciation as just following the rule, rather than a competitive devaluation,” they said.
Besides, markets have become less concerned about a hard landing scenario in the Chinese economy. China’s official manufacturing PMI came in flat at 50.1 in May, suggesting the economy is relatively stable at the moment, Macquarie analysts said.
“Looking ahead, given the eased PPI deflation and the ongoing property up-cycle, the down-side risk for this year is limited, in our view,” they said.
Shifting expectations for a stronger US dollar also helped keep investors calm about the recent depreciation of the yuan.
In addition, Macquarie analysts said currency short sellers have realised it is foolhardy to challenge the PBOC.
“The recent experiences have taught the markets ‘Don’t fight the PBOC’, which has the biggest balance sheet among all central banks globally and could easily squeeze short sellers in the offshore RMB market,” they said.
CICC analysts noted that Shanghai and Hong Kong stocks notched solid gains in the last two weeks of May, even as the yuan was volatile.
“Risk appetite seemed to be less repressed by the RMB factor this time,” said Xiangrong Yu and Hong Liang, analysts for the Chinese investment bank.
The calm market response may be due to eased pressure on capital outflows, as the corporate sector has paid down foreign debt they said.
China’s foreign currency debt decreased by US$96.9 billion in the second half of 2015, thus “the risk associated with unhedged foreign borrowings should have been reduced”, they said.
Foreign exchange reserves have also proved more resilient than previous expected. China’s foreign exchange reserves rebounded in March and April, reflecting the impact of a weaker US dollar on its non-dollar holdings, they added.
Regulators have also tightened controls over capital outflows through the trade channel and imposed new macroprudential measures to contain financial risks associated with capital outflows.