How to view the recent RMB “breaking 7”

Since May 17, the yuan has fallen below 7 to 1 against the dollar. The adjustment continued even after authorities warned on May 19 to curb speculation and rein in wild swings in the exchange rate. By May 26, the central parity rate of the onshore RMB exchange rate and the interbank market closed at 4:30 PM (the same below) at 7.0760 and 7.0547 to 1, respectively.

The recent break of RMB 7 is the result of a combination of internal and external factors. Externally, the US debt ceiling talks stalled, the Fed tightening expectations are growing, the dollar index has stopped falling and rebounded; Internally, the latest data show that the momentum of China’s economic recovery slowed in the second quarter.

At the end of last year and the beginning of this year, under “strong expectations and weak reality”, the RMB exchange rate rose again above 7 to 1 and once rebounded by about 8 per cent; after February, the market entered a period of validation of expectations and the RMB retreated. The adjustment recently accelerated again, with the US dollar index rallying 1.6% between 17 May and 26 May, while the RMB exchange rate fell by 1.8% and 1.3% at the mid and closing prices respectively. During the same period, the RMB multilateral exchange rate remained largely stable, with the Wind RMB Exchange Rate Advance Index falling by a cumulative 0.6% and rising by a cumulative 0.1% year-to-date.

Despite the recent “7” break, the yuan has not deviated from the baseline scenario — that is, if the “three stability” work is completed as scheduled this year, the yuan exchange rate may be broadly volatile, slightly stronger, similar to 2021. This is because the exchange rate this year mainly depends on the economic fundamentals. Although there are some differences in the current market on the slope of the future domestic economic recovery, the basic consensus is that the world economy faces downward risks and the Chinese economy is expected to recover in general.

Wide swings would have meant a two-way exchange rate, rather than a one-way linear appreciation. The Political Bureau meeting of the CPC Central Committee held at the end of April made it clear that the current economic turnaround is restorative. In the domestic economic shock recovery process, good news and bad news, do not know which is the first to arrive.

The yuan has broken below and above 7 several times since 2019. The reason why the RMB “broke 7” was hot speculation in the market still reflects the inertia thinking that the rise and depreciation of the RMB are equal to the rise and depreciation pressure and expectation. This goes against the grain of the market. In fact, with the increase of RMB exchange rate flexibility in recent years, market players have become more and more rational, and the exchange rate leverage adjustment function of “low (appreciation) buy high (depreciation) sell” is playing a normal role.

On April 18, after the release of first-quarter economic data, the yuan fell below 6.90 to 1. In this context, from April 18 to April 28, the average daily turnover of interbank market spot inquiry transaction increased by 39.7% compared with that from early April to April 17. In the month, the exchange rate of foreign exchange collection and settlement on behalf of clients by banks excluding forward performance was 57.9%, up 9.9 percentage points from the previous month and 3.8 percentage points higher than the exchange rate of foreign exchange purchase and payment, reflecting the overall increase in the market’s willingness to settle foreign exchange. In the same period, banks’ forex settlement and sales, including options, swung to a surplus of $23.7 billion from a deficit of $3.9 billion in the previous month. In the current round of RMB exchange rate adjustment from May 17 to May 26, the average daily transaction volume increased by 22.4% compared with that from early May to May 16, which does not exclude the fact that enterprises continue to “settle foreign exchange on high”.

On May 19, the first meeting of China’s Foreign Exchange Market Steering Committee pointed out that due to various factors, the recent two-way fluctuations of the RMB exchange rate are obvious, warning to correct pro-cyclical and unilateral behavior when necessary. At the same time, we will urge members of the mechanism to maintain stability in the foreign exchange market. On the same day, the domestic and foreign exchange rate of RMB trading prices appeared a wave of large pull back. But after that, the relevant departments did not introduce new policy measures, the RMB exchange rate continued to adjust the market.

In fact, this should be no surprise. Because the foregoing meeting cautioned the market at the same time, also affirmed that “the breadth and depth of China’s foreign exchange market is expanding, has the ability of independent balance, the RMB exchange rate also has the power and mechanism to correct deviation, can maintain basic stability at a reasonable and balanced level.” Confidence in the resilience of the onshore foreign exchange market is precisely why regulators have so far held back. That is because when foreign exchange markets are functioning smoothly, a regulatory onslaught would create unnecessary confusion.

At the Central Economic Work Conference at the end of last year, we reiterated the need to keep the RMB exchange rate basically stable at an appropriate and balanced level for the first time in a year. The above-mentioned announcement of the meeting on May 19 released the signal of maintaining the stability of the exchange rate, which is to remind the market participants that relevant departments have paid attention to the fluctuations of the foreign exchange market, and the next step will be to strengthen the supervision and management, monitoring and analysis, strengthen the guidance of expectations, and to act when necessary.

As for the recent decline in the domestic stock market, there was also net selling under the mainland stock Connect, which cannot simply be attributed to the fluctuations of the RMB exchange rate. Because there are many factors affecting the stock market and currency markets. Most of the time, the stock market and the currency market have their own rules and rhythms and do not move in sync. Occasionally, the stock market and the currency market rise and fall in tandem, also because of the same risk attributes, a certain event occurred, in the two markets caused the reaction in the same direction. Therefore, this kind of stock exchange resonance is more correlation than causation. In addition, due to China’s large trade surplus and small private debt, the depreciation of the RMB is generally positive for the improvement of listed companies’ profits, which cannot simply be seen as a negative for the stock market. Whether it is to stabilize the foreign exchange market or the stock market, China needs to do its own thing well and promote the overall improvement of the economy.

With the gradual accumulation of positive factors, it is expected that China’s economy will continue to recover, which will form a strong support for the stability of the RMB exchange rate. In the face of two-way fluctuations of RMB exchange rate, domestic enterprises should strengthen the awareness of risk neutrality, actively use local currency pricing and settlement and foreign exchange derivatives, and control currency mismatch and exchange rate exposure. Of course, receiving foreign exchange and paying foreign exchange is also a natural hedge against the risk of exchange rate fluctuations. Avoid coveting the high yield on dollar deposits, as the renminbi could easily eat up the spread between local and foreign currencies once it recovers from current levels.