China is undertaking structural reforms and at the same time facing slowing growth. One of the biggest financial reforms recently is the introduction of greater market forces in the USD/CNY fixing process. This led immediately to a limited devaluation of 3% to 6,40. Since then the spot fixing has retraced to 6,31, guided by intervention obviously. In the offshore market USD/CNH moved from 6,20 to 6,50 at that same time. For many observers, the future of CNY can be seen in CNH. Massive intervention, even till this moment, has brought USD/CNH again back in line with USD/CNY around 6,32.
The prize China is eager to win is inclusion of the CNY in the SDR. Reuters reports that the IMF Board will most likely decide on this in November. It is generally expected that the Yuan will weaken after that, not instantaneously but carefully managed by the PBoC.
In the latest FX Forecast report the consensus opinion for USD/CNY is that CNY will weaken to 6,70 in 12 months time. This would represent 6% depreciation from current levels. Danske states: “we believe that the relative weakness of the Chinese economy compared with the US and continued Chinese growth risks favour a moderate weakening of the CNY over the next year.” And Scotia is equally cautious: “Broader market sentiment, positioning, and the will of policymakers to maintain stability are key factors as we consider the outlook for CNY. We remain biased to flow-driven weakness and hold a year-end USDCNY forecast of 6.60 “(and 6,75 for Q316).
This view is shared by most banks in the FX Prospect report, but not by all. One bank, Rabobank, sees USD/CNY moving considerably higher to 7,60.
They express their opinion in two recent papers, “CNY- Am I being too forward?” of October 9th and “Growth hits 6, CNY still set for 7” of October 19th.
In the latter they drill deeper down into the latest 3Q GDP release and find some interesting inconsistencies in the breakdown of this GDP number. This does suggest that the real economic situation might be worse than reported and that considerably more monetary easing next year may be on the cards, accompanied by more downside pressure on the CNY.
In the former paper they take a closer look at the FX reserve data. FX reserves have been declining since early 2014 but this has taken a turn for the worst recently. And although there are outflow stemming measures being taken, as well as inclusion in the SDR will definitely have a positive effect on capital inflow, Rabo argues that China is quickly heading to the minimum level of IMF suggested FX reserves. And that will in the end, how far or near that might be, stop intervention to support the CNY. As Rabo states it: “However, the lesson is that when a country has an open capital account, a pegged exchange rate, economic fundamentals that strongly argue for depreciation, monetary policy that supports the same view, and net FX outflows, then central bank intervention – even if camouflaged by using the forward market to take the pressure off the spot rate – merely delays inevitable market adjustments.”
And although past performance is not a guarantee of future results, it is a fact that one year ago Rabo was the only bank forecasting USD/CNY higher to 6,40 whereas the rest was looking for 6,10 or lower.