FX Flash – USD/CNY 6.80 target approaching

by: Roy Teo

In this publication: China FX reserves in October declined at a faster pace. Positive correlation between CNY TWI and USD TWI has broken down. 2016 year end USD/CNY 6.80 target approaching.


FX-Flash-USDCNY-6.80-target-approaching-8-November-2016.pdf (220 KB)


China FX reserves in October declined at a faster pace

China’s foreign currency reserves declined by USD 45.68bn in October, more than the fall recorded in August (USD 15.89bn) and September (USD 18.79bn) combined. We attribute the sharper decline in FX reserves due to larger capital outflows (due to firmer yields in the US) and valuation effects (stronger US dollar).




Positive correlation between CNY TWI and USD TWI has broken down

Historically the Chinese yuan trade weighted index (CNY TWI) and the US dollar trade weighted index (USD TWI) tends to move in tandem (positive correlation) due to China policy makers preference for a less volatile currency. However this relationship has broken down in the past month. This is unusual. The CNY TWI has been relatively steady when the USD TWI strengthens. In our view, this is a reflection that China policy makers are letting market forces play a larger role in the direction in the CNY. However when the USD TWI declines, so does the CNY TWI. This is probably a reflection of China’s policy intent to engineer a gradual depreciation in the CNY. Indeed since October, the CNY TWI has declined by about 0.5% while the USD TWI has strengthened by more than 2%. Having said that we maintain our view that China will continue to smooth volatility in the currency via intervention activities in the spot market as reflected by a rise in trading volume in October.



2016 year end USD/CNY 6.80 target approaching

Our view that the onshore yuan (CNY) and offshore yuan (CNH) will decline to around 6.80 and 6.83 against the US dollar by the end of this year is materializing. This is reflected by both the onshore and offshore yuan forwards market. We expect depreciation pressures in the yuan to decline next year due to an improvement in domestic inflation and exports outlook. Deleveraging and restructuring large corporate debt remain a risk. Our 2017 year end USD/CNY target is 7.0.