USDCNH rebounds from 3.5-year low as PBOC attempts to cap Renminbi’s appreciation

14 Dec 2021

Despite the outperformance of the US dollar against most major currencies in 2021, the Chinese Yuan remains the strongest and it had even scored a new 3.5 year high against the greenback, gaining 2.5% this year. In this article, we will cover a few factors that have provided strength to the Chinese Yuan as well as some developments that may buoy the dollar against the Renminbi.

Carry trades help boost the CNH

The strong Chinese Yuan could be attributed to a few main factors. Firstly, the yield spread between the benchmark Chinese government 10-year bond and the US 10-year Treasury had aided the inflow of US dollars to invest in the higher yield yuan-denominated bonds. Even as the yield premium on two-year Chinese bonds over Treasuries with similar maturities narrowed more than 110 basis points from the November 2020 peak, the offshore Chinese yuan (CNH) continued to strengthen against the US dollar this year.

China’s robust exports

Apart from the yield spread that drove higher demand for the Chinese yuan, the Chinese currency was also bolstered by strong exports in 2021. China’s exports grew from USD263.7 billion reported in January 2021 to the latest USD325.5 billion in November. The robust exports also helped China achieve a record trade surplus.

Diverging monetary policy

On the horizon however, we do see a few emerging developments that could put the Chinese yuan’s resilience to the test. Firstly, the United States and China are currently at different cyclical phases which would call for diverging monetary policy that would benefit the greenback. The US economy has had a remarkable recovery from the Covid-19 pandemic and is now facing highest inflation in decades. China on the other hand, is challenged with a slow growing economy with the debt default from property developers Evergrande and Kaisa putting a downward pressure on the country’s economic outlook.

Hawkish fed amid persistent inflation

In the US, after the release of November Consumer Price Index (CPI) which recorded the highest inflation at 6.8% since 1982, markets are increasingly confident that the Federal Reserve remain hawkish and discuss about speeding up the tapering program which was due to end in June 2022, in the upcoming Fed FOMC meeting on 14-15 December. Additionally, traders are also anticipating the Fed to announce interest rate hikes following the conclusion of the bond-purchase program. These hawkish expectations are set the provide strength to the greenback.

PBOC loosens monetary policy

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On China’s front, fixed asset investments saw its year to date growth in October reducing from a year ago after peaking in early 2021. Moreover, the yearly retail sales growth remained lower than pre-pandemic levels. To battle the strong headwinds in economic growth, the People’s Bank of China (PBOC) announced a cut on reserve requirement ratio (RRR) for major commercial banks by 0.5 percentage points, releasing 1.2 trillion yuan (US$188 billion) worth of long-term liquidity into the interbank system on 15 December. At the same time, China also increased banks’ Forex reserve requirements for the 2nd time in 2021, in order to slow the pace of yuan’s appreciation. The diverging monetary policies between the US and China will narrow the yield spread and potential cap the Chinese yuan’s appreciation.

On China’s front, fixed asset investments saw its year to date growth in October reducing from a year ago after peaking in early 2021. Moreover, the yearly retail sales growth remained lower than pre-pandemic levels. To battle the strong headwinds in economic growth, the People’s Bank of China (PBOC) announced a cut on reserve requirement ratio (RRR) for major commercial banks by 0.5 percentage points, releasing 1.2 trillion yuan (US$188 billion) worth of long-term liquidity into the interbank system on 15 December. At the same time, China also increased banks’ Forex reserve requirements for the 2nd time in 2021, in order to slow the pace of yuan’s appreciation. The diverging monetary policies between the US and China will narrow the yield spread and potential cap the Chinese yuan’s appreciation.

Technical analysis

USDCNH is captured in a descending channel stretching back to July this year. Technical indicators like the Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) shows that bearish momentum dominates the pair. However, a bullish divergence on the RSI could hint a rebound of prices. After hitting the 6.33 low last week, the pair rose to challenge the 23.6% Fibonacci level at 6.37 but was rejected back below the resistance level. Looking ahead, as long prices remain below R1 (6.3768), the downside pressure to retest S1 (6.33) low remains high. In the event prices breach below S1, the next support for USDCNH lies at S2 (6.235) which was March 2018 low. 

Key events to watch this week:

Tuesday, December 14

USD – Produce Price Index ex Food & Energy (YoY)(Nov)

Wednesday, December 15

CNH – Industrial Production (YoY)(Nov), NBS Press Conference, Retail Sales (YoY)(Nov)

USD – Retail Sales (MoM)(Nov), Retail Sales Control Group (Nov), Retail Sales ex Autos (MoM)(Nov)

Thursday, December 16

USD – Fed Interest Rate Decision, Fed’s Monetary Policy Statement, FOMC Economic Projections, FOMC Press Conference, Housing Starts (MoM)(Nov), Initial Jobless Claims (Dec 10), Philadelphia Fed Manufacturing Survey (Dec), Markit Manufacturing PMI (Dec), Markit PMI Composite (Dec), Markit Services PMI (Dec)


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