Investment Research
12 August 2015
Strategy
CNY follow-up – clarifications and confusion
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There is a lot of confusion about the reform of the Chinese currency system. In
this short Q&A we aim to clarify what China has actually announced and what
are the implications.
What is clear is that China has changed its fixing methodology. This implies that
the daily fixing will be based on the previous day’ closing price. However,
uncertainty about how much PBoC will allow the spot to move around is high.
Our base case is that PBoC will intervene in USD/CNY to dampen CNY
depreciation. CNH/CNY spread is set to remain high short-term on heightened
risk premium but fall over time on arbitrage flows. Nordic corporates should use
CNH rather than CNY NDF versus local currencies to hedge FX risk.
Why did the CNY reference rate jump again today when the PBoC referred to
a one-off adjustment yesterday?
It was a bit of surprise for many in the market that the reference rate jumped again today
because it was a common understanding that it was a “one-off adjustment”. However,
what the People’s Bank of China (PBoC) actually said in its Q&A statement yesterday
was that “after the improvement of the quotation of the RMB central parity, the market
makers may quote by reference to the closing rate of the previous day and, therefore the
accumulated gap between the central parity and the market rate received a one-off
adjustment” (our underlining). Today the PBoC published another Q&A statement
clarifying the new methodology saying that “if the closing rate of previous day deviates
significantly from the central parity of that day, the central parity of the following day
will deviate from that of the previous day accordingly”.
Hence the rise in the reference rate today was in line with its new methodology and the
reference to one-off adjustment was not a signal that the PBoC would try to effect a oneoff increase but rather that the gap between the spot rate and the previous reference rate
closed and thus caused a jump. If the market closes above the reference rate of today, we
should expect another increase in the reference rate tomorrow.
Is it a deliberate devaluation – or a depreciation caused by market forces?
The move looks like a deliberate devaluation of the CNY caused by the weakness in the
economy. This may very well be the true motive of the Chinese authorities. However, the
devaluation has not been caused by PBoC selling CNY but because it is not buying CNY
to support it. China has seen capital outflows this year and the PBoC has had to buy CNY
to stabilise the currency, leading to a decline in the currency reserves. With China no
longer supporting the CNY, the market has adjusted and is weakening the currency.
Important disclosures and certifications are contained from page 4 of this report.
PBoC announcements on the changes
Announcement of reform of currency system,
11 August 2015
Q&A on change in methodology of reference
rate, 11 Aug 2015
More Q&A on the change, 12 Aug 2015
See key quotes at bottom of this paper
Source: PBoC
USD/CNY shooting higher
Source: Macrobond Financial
Chief Analyst
Allan von Mehren
+45 4512 8055
[email protected]
Senior Analyst
Flemming Jegbjærg Nielsen
+45 4512 8535
[email protected]
Global Head of FICC Research
Thomas Harr
+45 4513 6731
[email protected]
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Strategy
To what extent will PBoC keep its hands off and let market forces determine
the value of the currency?
In its statement today PBoC said it will take some time for the market makers “to adjust
quotation and trading practices” and that this “may lead to potentially significant
fluctuation of RMB central parity in the short run”. It would suggest a hands-off
approach in contrast with the general (and our) expectation that PBoC will aim to create
stability fast after allowing a short-term adjustment.
Today the PBoC seems to have been in the market to support the CNY. This could be a
signal that the CNY has depreciated as far as they want and decided to intervene to avoid
too much volatility and halt further depreciation.
However, it’s too early to say. The intervention took place when the CNY rose to just
below 6.45 versus the USD and thus had depreciated 1.8% compared to the reference
rate. The PBoC has to intervene intra-day also within the new system where it still has a
trading band of +/-2% (the reference rate today is 6.3306 and CNY hit a 6.4489 intraday
high). This does not rule out the CNY being allowed to depreciate further in a gradual
manner if market forces push it weaker. Time will tell, but we need a longer period to
evaluate what the new reaction function of the PBoC is under the new system.
Over the longer term, the PBoC mentioned a range of factors in its statement today that
should support a stable RMB (see quotes below). However, the market doesn’t seem to
share the PBoC’s view on some of these factors. Among other things, the PBoC refers to
relatively rapid growth in H1, a healthy financial system, and stable fiscal conditions as
drivers to support the CNY. These are factors that the market seems a lot more concerned
about, though, than the PBoC itself.
Chinese FX reserves
Note that part of the decline in FX reserves is purely due to valuation
effects due to the lower value of reserves in currencies that have
depreciated against the USD.
Source: Macrobond Financial
If the PBoC keeps its hands off completely (apart from defending the +/- 2% intraday
band, there could be a risk of a bigger depreciation. The PBoC will have to weigh the
risk, though, of a potential fallout from a negative spiral if further depreciation triggers
more capital outflows.
Significant uncertainty over the CNY and CNH
The bottom line is that there is significant uncertainty over the outlook for the CNY as it
will take time to see how the new system will work. Will market forces be allowed to
play out fully? And will that weaken the currency significantly? Or will the PBoC still try
to manage the float and if so to what extent? Our base case is that PBoC will indeed
manage the USD/CNY and thereby dampen spot and fixing volatility. CNH typically
overshoots CNY as it is more or less a freely floating currency, which does not have the
policy anchor in the form of the daily USD/CNY fixing. Expect CNH/CNY divergence to
stay in the short term as the market digests China’s new FX system, but to fall over the
medium term on arbitrage flows. With the current CNH/CNY spread, Chinese importers
will have an incentive to sell USD in the offshore market which will over time erode the
CNH/CNY premium. Short term, CNH will remain more volatile than CNY but the
divergence in CNH/CNY volatility should also narrow as uncertainty regarding China’s
new FX system fades.
CNY/CNH divergence
Source: Macrobond Financial
The main message we want to get across to Nordic corporates is that 1) they should begin
to treat CNY as an independent currency rather than treat it as a USD proxy; and 2)
Nordic corporates should shift hedging from CNY NDFs to CNH DFs as the curves will
converge and liquidity in USD/CNY gradually disappear. For more details on FX
Strategy suggestions see FX Strategy: China’s big bang: CNY devaluation and market
implications, 11 August 2015.
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Key quotes from PBoC announcements in last two days:
11 August, 2015
On depreciation of CNY and one-off adjustment:
“We noticed that the central parity of RMB against US dollar of 11 August changed (in
the depreciation direction) by nearly 2% compared to that of 10 August”.
“...after the improvement of the quotation of the RMB central parity, the market makers
may quote by reference to the closing rate of the previous day and, therefore the
accumulated gap between the central parity and the market rate received a one-off
adjustment” (own highlight with italics).
“The market still needs some time to adapt. The PBC will monitor the market condition
closely, stabilizing the market expectation and ensuring the improvement and the
formation mechanism of the RMB central parity in an orderly manner”
12. August, 2015
On the rise in central parity for second day in a row:
“Due to the existence of intra-day fluctuation in FX market, if the closing rate of previous
day deviates significantly from the central parity of that day, the central parity of the
following day will deviate from that of the previous day accordingly”
“It is clear that under the managed floating exchange rate regime, the fluctuation of RMB
central parity is normal, reflecting not only the enhancement of the market-orientation,
but also the key role played by market demand and supply in the formation of the
exchange rate”
On the short run development:
“It will take some time for the market makers to adjust quotation and trading practices, as
well as explore and find the equilibrium price... This may lead to potentially significant
fluctuation of RMB central parity in the short run” (own highlight with italics).
“After a short period of adaptation, the intra-day exchange rate movements and the
resulting central parity fluctuation will converge to a reasonable stable zone”.
On longer run expectations for CNY:
“In view of both domestic and international economic and financial condition, currently,
there is no basis for persistently depreciation of RMB... First, China registered a relatively
rapid economic growth in the first half of 2015... Second, China has maintained a current
account surplus for a long time... Third, the international demand for RMB-denominated
trade, investment and asset allocation is gradually increasing... Fourth,...We believe that
the market will have a more rational judgment on exchange rate after the temporary shock
of a rate hike [on the Fed and USD]... Finally, China maintains abundant foreign
exchange reserve, stable fiscal condition and a healthy financial system, which should
help bolster a stable RMB exchange rate”.
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Disclosures
This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske
Bank’). The author of the research report is Allan von Mehren, Chief Analyst.
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