TSLombard with the note.
The dollar is in the driving seat and Beijing’s efforts to maintain a sovereign monetary policy and managed currency are being tested by markets. Growth and rate differentials have driven USDCNY down 12.9% YTD in line with EM peers. The broader CFETS basket is only 1% weaker, but it is the dollar that matters most for trade, financing and sentiment. The coming trade surplus weakness and widening Fed-PBoC rate divergence will add yet more pressure to USDCNY. China FX rates are a political and monetary policy choice. Around the Party Congress next month, politics will dominate; this will mean stepped-up intervention, likely beginning in the second week
of October – signalling has already started. But beyond the Congress, growth is the priority: China cannot tighten and more unorthodox tools to defend USDCNY are equally unpalatable. We expect further currency weakness and revise our six-month USDCNY forecast to 7.4, up from 7.2 previously. Globally, there is a risk of self-reinforcing RMB and trade competitor FX weakness resulting in broader dollar strength.
Growth and rate differentials are driving RMB depreciation. Omicron has fully reversed the economic paradigm that drove RMB outperformance. China growth is slumping under the dual pressure of Covid-related restrictions and property-sector weakness, while the US rebound has been rapid and inflationary. With the US-China yield gap at its widest on record and pessimism about the domestic economy high, foreign outflows have driven the RMB decline, with household and China corporate outflows relatively muted. Steve Blitz, our Chief US economist, suggests a terminal rate of 5.5% may be necessary to induce a US recession and a Fed pivot. In China, we see another 10bps of policy rate cuts in 2022 and an additional 50bps RRR reduction or equivalent to prevent a further slowdown in activity. Foreign selling will continue.
