FX comment – Outlook for the Chinese yuan remains bright

by: Roy Teo

  • China manufacturing PMI rises to highest level since April 2012
  • Outlook for the Chinese yuan remains bright

China manufacturing PMI in July rises from 51 to 51.7

China’s manufacturing PMI rose from 51.0 in June to 51.7 in July, higher than market expectation of 51.4. This is the fifth consecutive month of gains and the level is the highest since April 2012. This reinforces our view that the economy likely troughed in the first quarter and our 7.5% GDP forecast for 2014 should be achieved. Nevertheless declines in the property market will continue to pose downside risks to the economy. Having said that around 20 cities mostly in the second and third tier where inventories are high have lifted or eased bans on ownership of more than one home. Sales volume should also improve due to price incentives from developers and a shortened mortgage approval and disbursement period.

Outlook for the Chinese yuan improving

Since 16 July when China’s Q2 GDP report showed that economic growth firmed from 7.4% to 7.5%yoy, the yuan has strengthened from above 6.20 to 6.17 against the US dollar. This is despite the central bank raising the fixing rate from 6.1535 to 6.1675. We judge that the policy intent to engineer a weaker currency will not persist in the coming months as the central bank will be more tolerant of capital inflows and allow a gradual appreciation in the currency as the rebalancing in the economy takes shape and the recovery takes hold. Indeed investor sentiment in the currency has improved (onshore spot discount to the fix has narrowed to 0.1% from 1.6% in April 2014) and the options market demand to hedge further weakness in the currency has also eased to the lowest level this year. We maintain our year end target of 6.10 for the Chinese yuan.