We think the renminbi (RMB) stands poised to appreciate versus a basket of currencies, and more so vis-à-vis the USD.
Why the jump? As global trade has slowed dramatically amid COVID-induced shutdowns, China has benefited from its “first in, first out” experience with the pandemic and associated easing of social distancing restrictions. China’s trade surplus has also rebounded to a recent year high. This export outperformance has helped China’s economy recover faster, and with less policy stimulus than seen in other major economies. We think this export outperformance will likely continue in the coming months.
As for what it means for investors, we think the renminbi (RMB) stands poised to appreciate versus a basket of currencies, and more so vis-à-vis the USD. This is also supported by China’s all-time high interest rate differential vs. the U.S. and other developed markets. Risks to this view include a sharp global (and particularly U.S.) consumption slowdown or a return of the U.S.-China trade war.
To add further context to our view, it’s important to understand just how impressive China’s export performance has been.
As mentioned above, China’s share of total global exports has shot up to nearly 20%. However, it’s important to stress that China’s exports aren’t strong due to growing global demand; in fact, global demand remains weak. China’s strength lies in its ability to take market share as it recovers ahead of the rest of the world.
European import trends clearly show this factor at play. EU imports were down -20% in the second quarter, as domestic demand collapsed as a result of COVID shutdowns and weaker consumption. This resulted in a dramatic drop across all major import partners…except China. Even in an environment of substantially weaker demand, European imports from China rose from April to June, and that strength is likely to continue as broad consumer trends continue to favor China’s producers.
What it means for investment: strong export performance points to further RMB upside
We think this return to a large trade surplus has an important implication for the RMB. Despite appreciating three per cent against the U.S dollar since May, the RMB likely has further upside.
Given the extraordinary strength in China’s exports, one might think that the currency should have appreciated more. After all, much of the appreciation against the dollar is simply a matter of broad dollar depreciation. On a trade-weighted basis, however, the renminbi actually depreciated in July, despite its massive trade surplus, and remains towards the bottom of its trade-weighted band.
We think there are a few potential explanations for why the currency hasn’t been stronger. First, currency settlement data suggests that only 32% of July’s export revenues were repatriated, meaning that most dollars earned abroad weren’t exchanged back into RMB. This implies less of an impact on the currency’s value. Second, there may be outflows elsewhere; corporate dividend outflows (or, when companies pay out dividends), for example, tend to occur in the summer. Lastly, although China’s official FX reserves have not increased (as would occur if there is intervention to keep the currency undervalued), a number of indicators suggest that state-owned banks have been buying dollars; in other words, the “FX reserves” are on state-owned banks’ balance sheets, instead of those of the People’s bank of China (PBOC). It’s hard to say conclusively if this is due to the banks’ own FX requirements, or more tacit intervention to help slow the pace of appreciation.
The takeaway is that none of the above–be it conversion delays, seasonality, or policy–are likely to counteract appreciation from here, which is supported by a large trade surplus, positive terms of trade shock, and significant gains in export market share. In addition, China’s yield advantage over developed markets is at an all-time high, leading to much stronger fixed income portfolio inflows so far this year. This is just an additional factor supporting the currency.
Risks to this view: consumer slowdown or a re-focus on trade imbalances
Robust U.S. fiscal stimulus has been both a driver of U.S. growth and China’s exports. The importance of the U.S. consumer as a key growth driver for China harks back to pre-Global Financial Crisis days, and raises risks that a slowdown in U.S. growth will also impact China’s recovery. In particular, the much expected next round of U.S. fiscal stimulus may be at risk, as Washington seems at a stalemate over what the bill should include. The risk then follows that a fall in consumer spending, particularly in the U.S. (which has been a key driver of global demand in the COVID recovery phase) could cause China’s export growth to slow.
In addition, the aforementioned large and growing trade imbalances across the world could soon result in increased political pressure. The trade relationship and positive official statements around the “phase one” deal have been the only bright spots in the U.S.-China relationship. However, with China significantly lagging in its purchase targets for 2020 (see chart below), and the U.S. trade deficit with China widening significantly, it raises the possibility that the deal could come under pressure before the upcoming U.S. elections. Additionally, if the current administration is re-elected, trade imbalances and the RMB could very well move back into the spotlight post-election.
Putting it all together
We think China’s export strength will likely lead to a stronger RMB. This is supported by China’s all-time-high yield advantage over developed markets. This also bolsters our positive view on onshore Chinese equities (A-shares) and Chinese government bonds (CGBs). While a sharp slowdown in global (particularly U.S.) consumption and a return of the trade war are risks to this view, we’re broadly constructive given that the economic recovery around the world continues.
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