China’s steady hand on falling yuan bolsters investor confidence
Hannah Anderson says the Chinese authorities’ timely intervention to stabilise the renminbi, in the face of a slowing economy amid trade war tensions, has reset investor expectations
Worries about internal and external fragilities recently sparked a steep slide in the Turkish lira. And a weakening economy and a large current account deficit prompted a sell-off in the Argentinian peso. As these events grabbed headlines, investors are searching for opportunities in other emerging economies, which are, nevertheless, similarly under stress.
Since April, the Chinese renminbi has suffered some of the biggest declines of any currency in Asia (down 9 per cent since April 1). Does this mean China is facing a rapidly worsening domestic situation that investors should be wary of?
A quick glance at the Chinese equity market would indicate this is the case. The benchmark CSI 300 index is down 24 per cent from its highest point in January.
Other indicators similarly suggest some grounds for worry. High-frequency activity indicators, like purchasing managers’ indices, showed slowing output over the first half of the year, while China posted a current account deficit during the first six months of the year – meaning it imported more than it exported.
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Bank lending and corporate investment have also slowed in 2018. Meanwhile, tensions between the US and China over trade remain high. All together, these factors indicate that China’s economy is in the middle of a slowdown and that investors would want to hold fewer Chinese assets than they once did.
Yet, over the past week, the renminbi has risen almost 1 per cent. Such a rally runs counter-intuitively to the way investors normally treat emerging market currencies, where the exchange rate acts as a release valve for the stress of a weakening domestic situation.
Nothing has changed dramatically in the macroeconomic picture for China and fears about the trade dispute with the US still hang over investors’ heads.
The turnaround came about for the simple reason that, as with many things in China, the actual level does not matter much, but the pace of change does. And the government has been successful in slowing the pace of depreciation.
Slower depreciation alone may seem a poor reason for investors to start betting on outright appreciation. But the way Chinese policymakers adjusted the US dollar-renminbi exchange rate, plus earlier administrative regulations to make selling the yuan more expensive, has reset investor expectations.
Chinese officials announced a week ago that they would resume using a “counter-cyclical factor” in setting the daily central parity rate for the yuan (the yuan is allowed to trade within a 2 per cent band above or below this rate every day). Offshore traders pushed the yuan up 300 basis points after this announcement.
While officials said they reintroduced this factor at the start of August, confirmation that the government was actively intervening to stabilise the currency – the stated goal behind reintroducing the counter-cyclical factor – was enough to spur an upswing.
This interplay between expectations and the speed of change is crucial for investor sentiment towards China. Nothing has fundamentally changed, but investor sentiment seems to have shifted in a more positive direction.
Keeping the scale of domestic stresses in China in mind is important, too: the slowdown this year – a result of policies aimed at ensuring financial stability and a natural rollover in momentum after a strong 2017 – is mild.
Onshore equities have experienced intra-year drawdown of over 20 per cent on average over the past 15 years, and narrower spreads between the yield on Chinese bonds and ones denominated in other currencies make other currencies less attractive to renminbi investors.
When compared to many other emerging economies, these factors mean the yuan has fewer reasons to continue to fall rapidly. That is not to say it will not end 2018 at a lower point than it is now, but the pace of change should be slower than it has been so far this year.
Stability is paramount for domestic policymakers and the currency will only be allowed to act as a release valve for small amounts of stress. Luckily for them, domestic stresses in China are mild, especially compared to the situation in the other emerging economies mentioned earlier.
Hannah Anderson is a global market strategist at JP Morgan Asset Management