Pressure on the RMB exchange rate to depreciate resurfaces in early March 2021
Since 1985, when “petrodollar” speculation dominated the exchange rate, the dominant factor was the movement of the interest rate differential between the two countries. As the interest rate differential between the U.S. and China narrowed continuously, the RMB began to depreciate again.
1 U.S. bond yields
On March 6, the U.S. Senate passed the $1.9 trillion new crown bailout bill with 50 votes in favor and 49 votes against.
On March 7, Saudi Arabia was attacked by drone air strikes (so familiar with the routine!) , oil prices surpassed $70 in one fell swoop, essentially tying the Epidemic before. Oil prices are up again, the U.S. is paying out again, Inflation expectations are high, and long-term U.S. bond yields are up again.
The current trouble for the U.S. is that either fiscal stimulus or monetary stimulus, or the expected economic rebound, will drive U.S. bond yields higher. And once the U.S. bond yields go higher, risk assets will have to reprice, which will bring down the U.S. economy.
2 Choice
But U.S. bond yields are ultimately moving higher. To follow? Or not to follow? The choice is left to other countries.
How does mainland China’s monetary policy choose? The exchange rate issue is a precondition for the stability of the Chinese economy (the choice to protect housing prices and abandon the exchange rate is impossible), so in the long run, I am afraid that the Chinese monetary policy still has to follow. But in the short term (when the exchange rate is not under pressure) monetary policy may have to take into account the “no sharp turn”.
From the past two months of 2021, the dollar ten-year Treasury yield rose from 0.95% to 1.59%, up 64 basis points; but China’s ten-year Treasury yield rose from 3.22% to 3.26%, up 4 basis points. Chinese monetary policy from the beginning of the year to date, are reflected in the “no sharp turn”, but also led to a rapid narrowing of the U.S. and China interest rate differential, in October 2020, the U.S. and China interest rate differential reached 252 basis points, the yuan rose fiercely.
Since around February 20, 2021, the spread has fallen below 200 basis points, and by March 2021, it has fallen to 169 basis points. The RMB exchange rate has fallen from 6.39 to the current 6.52, and the depreciation trend is confirmed.
The narrowing of spreads and exchange rate depreciation will generate a double loss, which will create a self-reinforcing characteristic. If the US-China spreads are not repaired in Time, the RMB depreciation trend may accelerate itself.
Along with the growing trend of RMB depreciation, the Chinese stock market has been falling continuously since mid to late February. In less than a month, the Shenzhen Composite Index has fallen 14% from its high.
3 Problems
The growth rate of social financing in mainland China has been turning around since November last year, and the pressure of debt problems and asset price risks is increasing. Obviously, following the US interest rate hike will amplify this risk.
1) Debt. the scale of maturing debt of real estate enterprises is expected to exceed 1.2 trillion yuan in 2021. In addition, there is a large amount of debt maturity due to be deferred during the epidemic this year.
2) Housing stocks. Over the past month, the SSE once fell 7.5% from its high and the SZSE once fell 14% from its high. The housing market is reacting more slowly than the stock market, and the pressure may be delayed. It is important to note that this is in the context of China’s monetary policy remaining anchored (not following the rise in US bond yields).
Against the backdrop of the sharp market rate hike experienced by the US dollar, the move to maintain monetary policy stability in mainland China certainly helped stabilize domestic debt pressures and asset prices, but it also led to a rapid narrowing of the US-China interest rate differential and the pressure began to be shifted back to the exchange rate. The situation seems to be back to 2018-2019. But perhaps slightly differently, according to CDS data, foreign investors took a big position in Chinese bonds in 2020, buying a net of more than a trillion RMB. another 267.6 billion in the first two months of 2021. Foreign investors now hold $3.15 trillion in Chinese bonds, compared to just $1.51 trillion in the same period in 2019.
A large amount of highly liquid foreign capital has entered mainland China, and if the US-China interest rate differential continues its narrowing trend, it may reverse the trend of foreign capital inflows, with funds moving in and out quickly or impacting the RMB exchange rate.
Given the growing volume of highly liquid foreign capital in China, China’s monetary policy will pay more attention to external pressure, and when the exchange rate encounters pressure, mainland China’s monetary policy may be tightened more quickly.
According to the International Finance Association, the amount of money flowing into emerging market stocks and bonds fell sharply to $31.2 billion in February from a record $107.4 billion in November last year. The influx of money into developing country assets has started to slow. As long-end U.S. bond yields move further upward in March, developing country flows may reverse.
In early January 2021, the US-China interest rate differential was 230 basis points and fell to 210 basis points at the end of the month, with foreign institutions buying a net $171.9 billion of Chinese bonds; in early February 2021, the US-China interest rate differential was 210 basis points and fell to around 190 basis points at the end of the month, with foreign institutions buying a net $95.7 billion of Chinese bonds, a drop in net buying of nearly half; in early March, the US-China interest rate differential fell to 169 basis points.
Will the inflow of foreign funds into mainland China be reversed?
Exchange rate stability is a precondition for asset price and debt problems and even stability. Once a reversal occurs, either tightening monetary policy to support the exchange rate (tightening hits asset prices) or not tightening monetary policy to allow the exchange rate to depreciate (outflows hit asset prices) will exert pressure on asset prices and debt issues.
Summary.
Exchange rate problems, asset prices and debt risks have emerged simultaneously, and there is no more room for monetary vacillation.
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