What’s driving the Chinese yuan stronger and what’s next?

31/05/2021

In essence, the central bank does not want investors to take the appreciation of Chinese yuan for granted.

Chaoping Zhu

Global Market Strategist

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The Chinese yuan has appreciated by close to 3% against the U.S. dollar since the end of 1Q 2021 to 6.37, the strongest since May 2018.

There are a number of factors driving the Chinese yuan stronger, in our view.

First, the U.S. dollar index declined in recent months and this is typically associated with a stronger Chinese yuan given it is managed on a trade-weighted basis. However, we also note that this trade-weighted renminbi index has also appreciated by around 0.8%. Hence, there are other factors at play when it comes to driving the currency stronger.

Second, China’s export performance remains robust. Total exports of goods expanded by 43.8% in the first four months of 2021 compared with the same period last year. Total trade surplus hit USD 160bn, compared with USD 58bn in 2020 and USD 90bn in 2019. The recent COVID-19 outbreak in some Asian economies, such as India, the Association of Southeast Asian Nations and northeast Asia have disrupted their production and some orders are diverted back to China. This could continue in the near term, especially as we approach the peak season of production ahead of the holiday seasons in the U.S. and Europe.

Third, Chinese capital markets have also enjoyed strong international inflows as the onshore stock market has seen renewed momentum. CSI 300 (+4% in the past month) outperformed S&P 500 (+0.6%) and MSCI Asia Pacific (+1.3%). Net inflow northbound from Stock Connects hit a new high in April, with a total inflow of USD 16bn for April and May. Net inflow into the fixed income market was also sizeable at USD 8.3bn in April.

There is also the market expectation that the People’s Bank of China (PBoC) could tolerate a stronger Chinese yuan in order to counter the rise in international commodity prices and help cool down cost pressure for domestic producers and tame inflation. It has been more tolerant of Chinese yuan exchange rate movements in the past 12 months without significant intervention in the foreign exchange market.

That said, the central bank has started expectation management, with PBoC Vice Governor Liu Guoqiang reiterating the central bank’s desire to maintain Chinese yuan stability around a reasonable equilibrium level, with two-way flexibility under market forces. On May 31, the PBoC also announced to increase the reserve requirement for foreign exchange deposits from 5% to 7%, effective June 15, which should marginally reduce the market’s foreign exchange supply. In essence, the central bank does not want investors to take the appreciation of Chinese yuan for granted.

EXHIBIT 1: CHINESE YUAN EXCHANGE RATE: CFETS RMB* VS. U.S. DOLLAR
INDEX, JAN. 2016 = 100
Source: China Foreign Exchange Trade Center, FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management.
*CFETS RMB index is the China Foreign Exchange Trade System basket of 24 currencies traded against the Chinese renminbi. Past performance is not a reliable indicator of current and future results.
Guide to the Markets – Asia. Data reflect most recently available as of 31/05/21.

Investment implications

We expect the Chinese yuan is likely to remain well-supported because of strong export performance, sizeable trade surplus and ongoing capital inflow into Chinese capital markets for both tactical and structural factors. The PBoC may opt to curb appreciation momentum from time to time, but a stronger Chinese yuan has its benefits in keeping imported prices low and encourage international capital into the Chinese markets.

A modestly stronger Chinese yuan should also help international investors to focus on the fundamentals in the equity and fixed income markets, instead of worrying about foreign exchange rate risks. We continue to see rich opportunities in both onshore equity and fixed income market in China. In equities, China’s economic stability should be further boosted by accelerating vaccination progress. China has already administered 640 million doses of vaccines. The key growth drivers in consumption, technological development and policy to reduce carbon emission should continue to play out in the long term. In fixed income, despite the ongoing monetary policy normalization, the global search for yield should persuade more investors to tap Chinese government and corporate bond markets.

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