In November, the Chinese yuan, or renminbi (RMB) showed a volatile recovery. The onshore RMB closed at 7.0875 against the U.S. dollar (USD) on November 30, and the offshore RMB appreciated even more against the USD, closing at 7.0499, returning to the level of 7. On December 1, the onshore RMB continued to appreciate slightly against the USD at 7.0840, while the offshore RMB fell 0.56% to 7.0849 against it. In November, the RMB rebounded all the way back to within 7.10 from a high of around 7.30 at the end of October, appreciating by about 3%. This trend seems to indicate that the round of RMB depreciation that began in September has come to an end, and the RMB exchange rate has remained resilient despite sharp changes in the internal and external environment. With this, a recent Bloomberg article's headline read "China Wins Battle Versus Yuan".
Figure: Changes in Offshore RMB Exchange Rate (Left) and U.S. Dollar Index (Right)
Source: Investing.com; chart plotted by ANBOUND
The rapid strengthening of the RMB in November may come as a surprise to those who expected a bearish exchange rate, according to Bloomberg, as only two of 32 analysts predicted the currency will be stronger than seven per dollar by year-end. Researchers at ANBOUND believe the recent rapid changes in the RMB's exchange rate are mainly due to policy factors outside China. On the one hand, changes in the country's COVID-19 policies have led to the strengthening of its economic recovery expectations; on the other hand, the Federal Reserve's monetary policy slowed down the pace of interest rate hikes, which in turn also slowed down the upward trend of the U.S. dollar. The short-term impact of these policy changes on the RMB exchange rate will be greater than changes in economic fundamentals.
As far as the external environment is concerned, after the Fed's continuous high-intensity interest rate hikes, it began to release signals to slow down the pace. At the same time, the U.S. inflation level began to fall from its high level, which also strengthened the market's expectations for a slowdown in the pace of its interest rate hikes. These factors make the trend of USD appreciation to slow, or even fall back. In November, the dollar index fell more than 5%, its worst monthly performance since September 2010. This means that the external pressure on the RMB exchange rate has been greatly eased. At present, the appreciation of the RMB exchange rate is still lower than the depreciation of the USD, which means that the RMB exchange rate may still have room to continue to rebound.
As far as China's domestic situation is concerned, under the continuous COVID-19 outbreaks, China's internal economic situation showed a sluggish state beyond previous expectations, whether it was consumption, investment, or foreign export. All these factors were originally a risk of further depreciation of the RMB exchange rate. However, the adjustment of the country's COVID-19 measures has greatly enhanced the market's expectations for its economic recovery. This factor has far exceeded the bearish reflection of economic fundamentals, leading to a significant improvement in future expectations. In this sense, changes in COVID-19 policies are currently the biggest variables affecting the Chinese economy. Such a shift is bound to make the RMB exchange rate begin to recover its "lost ground".
However, it is worth noting that this round of RMB exchange rate adjustment does not exactly end the short-position. If economic fundamentals recover less than expected, the RMB exchange rate will still see adjustments in the future. More importantly, a long period is required for the recent changes in China's COVID-19 policies to the time when the pandemic gets completely under controlled. In this process, exchange rate risks will still be quite significant in the face of repeated outbreaks, where the economic recovery will still be constantly affected. The Bloomberg article also stated that the adjustment of China's COVID-19 measures may still face challenges, and the rising trend of the RMB will cool down.
In terms of the external environment, although the Fed has signaled a slowdown and the pace of interest rate hikes will ease in the future, it still emphasizes the control of inflation, and it is too early to expect to end interest rate hikes or even turn to easing. Under this circumstance, with China's monetary policy that focuses on the domestic situation, the policy cycle gap between China and the U.S. still exists, or even widens. This will have an important impact on the long-term trend of the RMB exchange rate.
It is worth noting that although the RMB exchange rate showed an appreciation trend in November, its fluctuations were very significant, and adjustments of more than 100 points were already "normal", and there were many adjustments of thousands of points. This increase in the amplitude of "two-way fluctuations" may be in line with the "uncertain" goal of exchange rate policy, which is conducive to crowding out foreign exchange speculative transactions. That being said, this also brings hidden dangers to the stability of both the foreign exchange market and the domestic capital market, and could even cause market panic. From the perspective of the exchange rate policy objectives of the People's Bank of China, the stability of the RMB exchange rate in a reasonable and balanced state does not mean there should be no appreciation or depreciation, neither is it about attempting to change the exchange rate trend. Instead, it is to maintain the relative stability of the changing trend. Therefore, this kind of rapid rise and fall and sharp fluctuation of the market situation is not the intention of the exchange rate policy. At the same time, the increase in volatility reflects that expectations for the future are not stable, and many uncertainties have not been ruled out. Therefore, in the long run, the path of maintaining the stability of the RMB exchange rate remains challenging.
Final analysis conclusion:
The RMB exchange rate has been volatile and rebounding since November, indicating that the trend of currency depreciation that began in September is coming to an end. Changes in China's COVID-19 policies, as well as the adjustment of U.S. monetary policy have made the RMB exchange rate show signs of stabilization. However, in the long run, the long-term factors affecting the exchange rate are still at play, and market expectations remain volatile. Under such pressure, maintaining the stability of the RMB exchange rate remains challenging.
