EM FX Weekly – PBoC seeking a weaker yuan?

by: Roy Teo , Arjen van Dijkhuizen

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EM FX lower ahead of FOMC and further declines in commodity prices
PBoC allowing market forces a greater role ahead of FOMC meeting
No change in PBoC FX policy

EM FX lower ahead of FOMC and weaker commodity prices

Emerging market currencies were mostly lower in the past week as financial markets position for a US rate lift-off to take place likely next week. In addition, the resumed slide in commodity prices exerted downward pressure on currencies of commodity producers. Weaker oil prices is also likely to weigh on inflationary pressures in most emerging market economies, increasing the likelihood that monetary policy will remain loose for a longer period.

PBoC allowing market forces a greater role ahead of FOMC meeting next week

Since last Friday, we suspect that the People’s Bank of China (PBoC) has either refrained from or reduced its intervention activities in the currency market to defend weakness in the Chinese yuan. This is based on several observations.

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First, both the onshore (CNY) and offshore (CNH) exchange rates have depreciated significantly versus the US dollar over the past week. Second, both onshore and offshore short term rates have started to trend lower, reflecting an improvement in liquidity as intervention activities decline. Third, the onshore yuan divergence with the daily reference rate has also increased. Fourth, the offshore yuan (CNH) discount to the onshore yuan (CNY) has widened to above historical average. We suspect that the PBoC is allowing market forces to play a larger role in determining the exchange rate ahead of next week’s US FOMC monetary policy meeting (16 December). This is similar to what was observed during weeks before the September FOMC meeting. Nevertheless, ahead of the next FOMC meeting, we expect a CNH discount to the CNY of around 1000 pips to trigger action from the central bank.

No change in PBoC FX policy

We do not think that there has been a fundamental change in the central bank’s exchange rate policy. We still think that the PBoC is not willing to tolerate a too sharp depreciation of the currency, as that might trigger more capital outflows. Furthermore, the weak yuan fixing against the US dollar is not materially out of line with other currencies’ movements as the yuan has not declined substantially against its trade weighted basket of currencies. We still expect the CNY to weaken versus the USD in 2016 to 6.55 end-of-period. This is less pessimistic than what the forwards market are implying (above 6.70).151210-EMFX2