RMB Stays Steady Against a Strong Dollar

Since November, the onshore and offshore RMB exchange rates have been experiencing significant fluctuations, with both showing a declining trend on a monthly basisAs of the market close on December 11, the onshore RMB exchanged at 7.2678 against the dollar, a cumulative decrease of 1518 basis points or 2.13% since November 1. Similarly, the offshore RMB was valued at 7.2794, reflecting a drop of 1576 basis points or 2.21% over the same period.

Several analysts have identified the strengthening of the US dollar index as a major factor behind the recent depreciation of the RMBThe rise of the dollar index has indeed correlated with a certain level of depreciation in the RMB exchange rateIn early November, the dollar index surged significantly, further intensifying the devaluation pressure on the RMBAccording to data from Wind, the dollar index has consistently trended above 105 since November 6, peaking on November 22 at 107.4911, the highest level in nearly three months.

Looking at the recent trends, analysts believe that although the dollar index may continue to hover at elevated levels, its potential for further strengthening is limited due to various influencing factors, including the Federal Reserve’s moves toward a rate-cutting cycle

Even amidst a trend of bearish sentiment towards the RMB, the People's Bank of China (PBoC) is equipped with sufficient policy tools to stabilize the exchange rateIn the broader context, the stabilization of China’s economy, buoyed by a series of favorable policies taking effect, will provide significant support for currency market stability.

Current data indicates a recovery in both the onshore and offshore RMB as of December 11, with exchange rates breaking the 7.25 mark against the dollarAs of 15:30 on that day, the onshore rate was reported at 7.2440, up 320 basis points from the previous trading day, and even touching a high of 7.2422; meanwhile, the offshore rate reached 7.2477, reflecting an increase of 200 basis points and also marking new highs for December.

The volatility in RMB exchange rates in response to the strengthening dollar index can be attributed to deeper underlying reasons

• Dollar Wealth Management Assets Double Amidst Interest Rate Uncertainty
• RMB Stays Steady Against a Strong Dollar
• Developing Multi-Tiered Capital Markets
• U.S. Inflation Decline Set to Slow
• India's Q3 GDP Growth Hits Low, Economy Faces Headwinds

Tariff policies have heightened market demand for safe-haven assets, while these tariffs may also spur inflationary pressures within the United States, potentially delaying any rate cuts by the Federal ReserveA considerable factor behind the dollar’s strength is the heightened market expectations surrounding the “Trump trade,” with anticipated tariffs on trading partners that could be triggered as of January 20 of the following year, reinforcing the forecast for a further strengthening of the dollar relative to non-dollar currencies.

Wang Qing, Chief Macro Analyst, noted that if the US engages in a new round of trade wars in the upcoming year, currencies of the countries subject to tariffs will likely depreciate, thereby increasing the dollar indexHe Qing, Associate Dean of the National Finance Research Institute at Renmin University, expressed concern over “re-inflation” fears, which would diminish expectations for Fed rate cuts and result in a stronger dollar index

Historically, Fed interest rate hikes and cuts, along with market anticipations surrounding their decisions, have played crucial roles in influencing fluctuations in the dollar indexThe proposed policy mix of “cutting taxes domestically, imposing tariffs externally” is likely to increase import prices, reduce corporate taxes, and expand government deficits, triggering a series of reactions that have led to market fears regarding US “re-inflation.” This sentiment has also resulted in diminished expectations for forthcoming Fed rate cuts, which has played a significant role in the dollar index’s rise in recent months.

If the Fed delays rate cuts or even raises interest rates, it could widen international market interest rate spreads, attracting global capital inflows into the USAn increase in demand, coupled with relatively stable dollar supply, would contribute to dollar appreciation and strengthen the dollar index

Nevertheless, the Fed is still currently in a rate-cutting cycleHe Qing pointed out that during the previous hike cycle between March 2022 and July 2023, the Fed raised rates 11 times for a total increase of 525 basis points, indicating a strong policy inertia.

According to the CME FedWatch, predictions for the Federal Reserve’s meeting on December 18 suggest an 81.5% probability of a 25 basis point cut, a 14.9% chance of maintaining existing rates, and for the meeting on January 29, 2024, there’s a 62.6% likelihood of a 25 basis point cut, with a 10.1% chance of no change and a 27.3% probability of a 50 basis point reduction.

From the perspective of China, the widening gap in long-term government bond yields between China and the US has emerged as another significant driver of the dollar index’s riseXiao Yu noted that the increasing yield differential between Chinese and US bonds could cause the dollar to strengthen

Historical data shows a strong correlation between the yield spread and exchange ratesIn the offshore market, adjustments in this yield spread have long been a critical reference point for forex tradersThe rapid decline in the yield of Chinese 10-year bonds has further widened this differential, reigniting arbitrage trading in offshore marketsThese arbitrage trades driven by yield spreads are often important short-term factors impacting currency trends.

According to the China Foreign Exchange Trading System, the yield on China’s 10-year bonds stood at 1.84% as of December 11, remaining below 2%. Earlier, on December 2, yields dropped below the 2% mark for the first time, marking a historical lowIn contrast, US 10-year bond yields have fluctuated between 4.1% and 4.2% this year, even peaking at 4.4% in November.

He Qing indicated that the current high levels of US 10-year bond yields may heighten the appeal of US stocks and other risk assets, thereby exerting some short-term pressure on the RMB exchange rate

Yields on government bonds are vital references for risk assets like stocksThus, amid the widening yield gap between the US and China, the attractiveness of US dollar assets, as represented by US stocks, is likely to increase, potentially raising depreciation pressures on the RMBWang Qing concurred, stating that the deepening inversion of the US-China yield differential is bound to exert some downward push on the RMB exchange rate.

However, upon comprehensive review, as the trend of the US-China bond yield gap stabilizes, its impact on the RMB exchange rate is gradually returning to neutralHe Qing observed that the recent decline in bond yields is not necessarily detrimentalWhile a short-term dip in yields could lead to lower returns on RMB assets and thus some immediate exchange rate pressure, in the medium to long term, declining interest rates might foster economic strengthening and sustainable high-quality development, laying solid groundwork for stabilizing the RMB exchange rate.

Wang Qing emphasized that the implementation of this package of incremental policies aimed at stabilizing growth and the property market is a crucial driving force for determining the intrinsic appreciation or depreciation of the RMB

Conversely, the influence of the recent inverted US-China yield gap on the RMB exchange rate is waning.

What can be anticipated in the trajectory of the dollar index? Analysts posit that in the short term, a “strong dollar” may remain the predominant trading theme, with the dollar index likely sustained at elevated levelsAccording to Zhou Maohua, a macro researcher from Everbright Bank’s Financial Markets Department, persistent sticky inflation in the US and stronger “re-inflation” expectations could provide support for the dollar, indicating that the dollar may maintain a strong and volatile trend for some time to come.

However, the long-term outlook for the dollar index faces a complex environment, lacking the basis for a trend-driven appreciationThe Fed’s current rate-cutting cycle constrains the potential for dollar growthHence, from the perspective of dollar cycles, the broader environment does not support a trend-oriented strengthening of the dollar.

Wang Qing explained that considering the dynamics of economic growth and price trends, the European Central Bank is likely to implement deeper cuts than the US, meaning that the yield differential between Europe and the US will remain elevated

Concurrently, as the European economy recovers, Eurozone GDP growth may accelerate by 2025, potentially narrowing the gap with US economic growth, indicating limited room for significant increases in the dollar index next yearShould the US impose additional tariffs on more countries, the possibility of a trade war may trigger more safe-haven demand, potentially pushing the dollar index higher in specific periods.

UBS Wealth Management Investment noted that any structural changes stemming from policy shifts could significantly impact currency markets, where future changes in governance could come into playIn light of favorable macroeconomic indicators from the US enhancing the dollar's outlook, long-term concerns over trade tariffs or reduced immigration may hinder US economic growth and re-invigorate market expectations of Fed rate cutsThe dollar DXY index has rebounded by 6% from September’s lows, effectively reflecting nearly all the positive news for the dollar, with limited potential for further significant strengthening.

He Qing believes that there is limited space for substantial upward movement in the dollar index

Throughout 2023, the dollar index has fluctuated between 101.05 and 106.35, with this recent iteration of the dollar index approaching the October height of 106.35, indicating that substantial further increases are unlikelyIn the medium to long term, eventual economic data weakness, potential US debt crises, and the unfolding of the rate-cutting cycle may compel the dollar index to peak and decline.

Xiao Yu elaborated that should the US impose external tariffs, the foundational support for a strong dollar would be compromised, while China’s economic fundamentals and long-term growth prospects remain intactHence, there’s no need to be overly pessimistic regarding the future trajectory of the RMB exchange rate.

Moreover, the input of numerous viewpoints highlights that the approaching year-end will see many foreign trade enterprises needing to engage in concentrated currency conversion, providing some support for an appreciation of the RMB before year-end

He Qing noted that amidst the depreciation pressures faced by the RMB due to the dollar’s strength and other factors, the currency conversion activities of foreign trade firms can help offset such pressures by enhancing demand for the RMB and alleviating any imbalance in the market's supply and demand dynamics that may lead to RMB weakness.

It’s crucial to note that the RMB’s bidirectional fluctuations may become the normFor enterprises engaged in foreign trade, accurately predicting short-term exchange rate movements poses challenges, calling for caution against unilateral betsMarket participants should strive for exchange rate neutrality to avoid potential losses from speculative foreign exchange activities.

Wang Qing suggests that all firms, whether importers or exporters, should adhere to a principle of financial neutrality while utilizing foreign exchange hedging methods like forward contracts and options to manage exchange rate risks, especially given the ongoing volatility in the currency market

Increased reliance on the Chinese yuan for transactions can also serve as an effective means of hedging against exchange rate risks.

He Qing recommends that foreign trade enterprises adopt varied strategies to navigate the uncertainties within the current forex marketThis includes optimizing trade settlement methods, increasing the proportion of transactions conducted in RMB, thereby lowering exchange rate risks; evaluating foreign exchange positions in line with their risk tolerance and selecting appropriate foreign exchange derivatives to lock in rates; and diversifying market reach to reduce dependency on any single market, thus dispersing foreign exchange riskAdditionally, improving risk management frameworks and building dedicated teams to monitor, assess, and manage exchange rate risk will support informed decision-making for enterprises.

Data from the China Foreign Exchange Trading System shows that the RMB’s central parity rate against the dollar experienced noticeable adjustments in November

On November 6, the central rate stood at 7.0993, which rose to 7.1659 on November 7 and further climbed to 7.1927 by November 12, stabilizing between 7.18 and 7.19 into DecemberBy December 10, the central parity rate was recorded at 7.1896.

Observers have speculated that the upward adjustment of the RMB’s central parity, coupled with the expanded daily fluctuation limits for spot exchange rates, might indicate the central bank’s intention to proactively manage devaluation pressures.

Wang Qing elaborated that previously, during the rapid ascent of the dollar index, the depreciation of the RMB was relatively modest, allowing for an accumulation of passive devaluation momentumThe moderate upward adjustment of the RMB’s central parity can assist in dissipating this passive devaluation momentum, thereby alleviating depreciation pressuresThis aligns with the broader objective of market-oriented exchange rate mechanisms while preventing excessive accumulation of depreciation expectations and maintaining stability in the RMB exchange rate without drastic fluctuations remains a core aim of the central bank's foreign exchange policies.

Is there a risk of a uniform downward trend for the RMB exchange rate? Many opinions suggest that while the RMB may face short-term pressures due to complex domestic and international circumstances, the longer-term exchange rate relationship aligns with the quality of the country's economic development

Given the current revival and positive development of the economy, the prospect for a consistent bearish outlook on the RMB seems weakShould there emerge a tendency towards bearishness in the RMB exchange rate, the currency possesses ample resilience to navigate through the cycle and the central bank is poised to enact relevant measures to stabilize the exchange rate.

Wang Qing noted that given an increase in variables surrounding China’s external trade environment next year, some market expectations for RMB depreciation could arise, indicating a potential risk of a uniform downward outlook for the currency during specific periodsHowever, should this materialize, various stabilization tools, including adjustments to offshore liquidity of the RMB, would be enacted promptlyHistorical evidence suggests these policy tools can effectively recalibrate market expectations and mitigate the risks of excessive deviation in the exchange rate.

Zhou Maohua emphasized that in recent years, the RMB’s exchange rate has shown significant elasticity, with the central bank having access to an array of tools for stabilizing the exchange rate while possessing rich expertise in managing market expectations

In extreme scenarios, the central bank can stabilize the RMB exchange rate through adjustments to foreign exchange reserve requirements, risk provision reserves, issuance of offshore RMB central bank bills, and introduction countercyclical factors.

He Qing maintains that in the medium to long term, China has the capability and confidence to maintain relative stability in its exchange ratesChina adheres to a managed floating exchange rate system, supported by market supply and demand and referenced against a basket of currenciesThe central bank will carry out necessary interventions to prevent excessive volatility in the RMB exchange rate, maintaining its basic stability at a reasonable equilibrium level.

On the timing for any central bank interventions, Wang Qing emphasized the need to monitor the degree to which market exchange rates deviate from the central parity, looking for signs nearing a 2% threshold

Additionally, examining the implied volatility of domestic USD/CNY options for rapid increases or sustained levels above 5% is also crucial.

Since November, the CFETS RMB Index has generally stabilized around 100. In Zhou Maohua's view, the RMB's stable performance against a basket of currencies and the resilience of foreign reserves above 3.2 trillion dollars reflect the ongoing strength of the RMB, establishing it as one of the resilient currencies.

As reported by the State Administration of Foreign Exchange on December 7, China’s foreign reserves stood at 32659 billion dollars at the end of November 2024, marking an increase of 48 billion dollars or 0.15% from the end of OctoberThis achievement signifies continuous maintenance of reserves above the 3.2 trillion dollar threshold for 12 consecutive months, with the total foreign reserve figure stabilizing above 3.1 trillion dollars throughout 2023.

The Foreign Exchange Administration noted that in November 2024, the dollar index experienced an rise, propelled by monetary policies from major central banks and macroeconomic data

Factors such as exchange rate adjustments and asset price fluctuations contributed to the overall increase in foreign reserve scaleThe upsurge in China’s economic activity enhances market confidence, promising to uphold the stability of foreign reserve scales.

To this end, Zhou Maohua observed that a plethora of favorable policies have been enacted this yearIn terms of monetary policy, China has executed several cuts to reserve requirements and interest rates along with issuing special bonds; whereas fiscal measures have included tax reductions and intensified infrastructure effortsThese targeted policies not only facilitate immediate economic recovery but also promote long-term economic progress.

It’s noteworthy that a meeting on December 9 convened to analyze and prepare for economic endeavors in 2025 emphasized effective macroeconomic policies, expanding Chinese demand, promoting technological innovation, stabilizing the real estate and stock markets, and managing risks and external shocks, with a focus on maintaining expectations and energizing the economy for continued recovery.