In Brief

• The renminbi may be attractive to investors maintaining a selective approach to emerging market currencies, who are seeking higher-yielding alternatives to the US dollar.  

• Renminbi strength could have several drivers. First, China’s balance of payments is now neutral, supported in part by cyclical factors, such as better management of the pandemic resulting in stronger economic growth than other regions.

• Initiatives to open Chinese markets to foreign investors, leading to the further inclusion of Chinese assets in global indices, should also support renminbi flows and could increase central bank allocations to the currency. 

• We expect Chinese GDP should be back in line with its pre-Covid trend by 2021, while the US and euro area will take several years to make up lost output. This strong growth relative to other economies is helping to catalyse a rotation away from export-driven growth towards greater self-reliance, a model that should prove more tolerant of exchange rate appreciation.

• Regarding the outcome of the US election, we believe the risk premium for the renminbi would be lower with a Biden win, which would be positive for the currency, and remain roughly at current levels with a Trump win.

Rise of the renminbi

The renminbi has led the positive performance of Asian currencies against the US dollar  over the past quarter amid a tenuous recovery across global emerging market currencies.  The Chinese currency endured an extended period of depreciation pressure due to  deteriorating underlying currency fundamentals, policy rate differentials and trade  tensions with the US.

The Covid-19 shock has facilitated a re-statement of risks around the renminbi in light of  the global re-set of economic policy stances and a sharp, broad-based redistribution of  external balances. The renminbi may be attractive to investors maintaining a selective  approach to emerging market local currency-denominated assets, while seeking higher-  yielding alternatives to the US dollar; it is likely to benefit from China’s progress in  liberalising access to onshore capital markets and a period of growth exceptionalism  spurred by targeted policy accommodation (Exhibit 1).

EXHIBIT 1: Balance of payments and increased flows support the renminbi

* Assumes staggered inclusion into WGBI bond indices starting Oct 2021 up to 5%  weight and CNY share in global reserves ex-China rising 0.2pp/year.
Source: J.P. Morgan Asset Management, Bloomberg. Data as at 30 June 2020.

Cyclical and structural support

The balance of payment trends in China previously featured as a  negative factor in our broad assessment of the renminbi’s  valuation; a steady current account erosion since the early 2000s  was driven by negative demographic trends and episodic surges  of capital outflows that suggested incomplete currency  adjustments.

But the breadth of the economic shock caused by the pandemic,  compounded by idiosyncratic capital account factors, have  arguably changed the outlook for the year ahead. After a  negative first quarter caused by the initial shock of the  coronavirus outbreak earlier this year, China has quickly reversed  into a current account surplus, driven by resilient external  demand for its manufactured goods exports and unprecedented  mobility restrictions that are depressing imports.

In addition to these cyclical developments there are significant  structural forces at play, such as China’s efforts to internalise the  production of advanced manufacturing components, which has  accelerated with the uncertainty over trade agreements with the  US. This could sustainably decrease China’s demand for high-tech  imports. While bouts of trade data volatility are still possible,  depending on the near-term impact of the pandemic, China’s  external balance looks likely to be settling into a modest 1% to  2% of GDP surplus range over the coming year, a level consistent  with a fairly valued currency.

The positive cyclical support for the renminbi from the trade  balance is likely to be further amplified by China’s efforts to  structurally solidify its ability to compete for overseas investment  flows. Since 2017, gradual changes have facilitated greater  foreign investor access to renminbi-denominated fixed income  and equity onshore markets; this structural change was validated  by China’s ongoing inclusion into global bond and equity  benchmark indices.

The “coming of age” theme on an international scale for Chinese  local assets is particularly exceptional given the current risk-  averse environment; global emerging market currencies have  broadly lacked investor flows so far in this downturn. Deeper  local markets, more consistent with China’s importance to  regional and global trade, could also boost renminbi allocations  in global central bank reserve holdings. Furthermore, a  respectable yield differential over competing developed  currencies would play to the renminbi’s advantage.

In summary, without making any strong predictions about the  risk environment, one could rationalise an extended period of  support for the renminbi based on the scope for greater foreign  participation and an increase in index-eligible Chinese assets,  bringing annual gross inflows of up to 0.6% to 0.8% of GDP.

Chinese growth exceptionalism

Despite being at the epicentre of the coronavirus outbreak, China  has undoubtedly weathered the crisis much more successfully  than the rest of the world. The resilience of its economy to the  Covid-19 shock signals a newfound Chinese growth  exceptionalism. China is the only major economy expected to  avoid a recession this year.

Effective suppression of the virus has enabled a full reopening of  the economy, while other parts of the world are once again  increasing restrictions. Based on our growth forecasts, Chinese  GDP should be back in line with its pre-Covid trend by 2021, while  the US and euro area will take several years to make up lost output (Exhibit 2).

Importantly for the currency, China’s strong growth relative to  other economies is helping to drive a rotation away from export-  driven growth towards greater self-reliance. A more domestically-  driven growth model should prove more tolerant of exchange  rate appreciation. The lack of official pushback against significant  renminbi appreciation in the third quarter suggests this shift in  exchange rate policy is underway. Growth exceptionalism coupled  with a less interventionist stance are key ingredients to a  structural renminbi-appreciation trend.

EXHIBIT 2: Only china’s gdp is set to return to its pre-covid trend

Source: World Bank GDP constant prices USD, J.P. Morgan Asset Management  projections as of 5 October 2020.

Positive risk skew around (geo)political events

Ongoing trade tensions with the US have also driven a desire  for greater self-reliance. Clearly, the outcome of the US  elections will prove key in shaping future trade relations, as  well as other areas of confrontation such as intellectual  property and military expansion.

A Biden victory would likely reduce the current market risk  premium that reflects the erratic, unilateral unpredictability of  recent tariff policy. Trade policy under such a US administration  is likely to remain hawkish but more predictable and rooted in  multilateralism. Nonetheless, a lower risk premium should be a  positive driver for the renminbi. Under a second Trump  administration, the current risk premium would remain  embedded in the currency but is unlikely to rise materially. This suggests an appealing asymmetry in the renminbi’s  reaction to the elections.

Opinions, estimates, forecasts, projections and statements of financial market trends are based on market  conditions at the date of the publication, constitute our judgment and are subject to change without notice.  There is no guarantee they will be met. Provided for information only, not to be construed as investment  recommendation or advice.
All data are as at the date of this publication unless indicated otherwise.
Provided for information only based on current market conditions subject to change from time to time, not to be construed as investment recommendation or advice.
Forecasts and estimates are indicative, may or may not come to pass.
The manager seeks to achieve its objectives, there is no guarantee they will be met. Risk management does not imply elimination of risks.

0903c02a82a2dbf7