How long should you hang in there? That was the question for short-sellers of China’s currency this week after a Texan hedge fund gave up its longstanding prediction that the yuan would crash.
Mark Hart’s Corriente Advisors made money predicting the US subprime bust and the European debt crisis, but he is throwing in the towel in China after spending seven years and $240 million waiting for his bet to pay off. “I always thought we had a good risk-reward trade on, but we made a number of mistakes, including being way too early. And now the world has changed,” Hart told Bloomberg this week.
His hopes may have peaked last year, when the redback was in freefall against the greenback, dropping a record 6.5%. China’s foreign reserves were depleting just as quickly as the central bank sold dollars to slow its descent (see WiC351).
The renminbi has since pared most of the lost ground and as of this week it reached its highest level against the dollar for more than 15 months in its formal fixing by the Peoples’ Bank of China (PBoC).
In part, the recovery is down to the greenback’s weakness as investors lose faith in the tax cuts and infrastructural spending that triggered the ‘Trump trade’ last year. The Japanese yen’s attractiveness also appears to be undermined by North Korea’s missile threat.
But it is also a reversal of sentiment which turned markedly for the worse in August 2015, when the PBoC changed the way that it sets the currency’s price against the dollar. By widening the daily range in which the yuan was allowed to fluctuate, the central bank was allowing more say for the market. But the revamp was accompanied by a 2% devaluation of the currency, which sent the markets into a spin (see WiC292).
In their efforts to shore up the yuan in the months that followed, the authorities have tightened capital controls and squeezed liquidity in offshore trading centres, hurting speculators. At home the PBoC has also unveiled a new “countercyclical factor” that gives it more flexibility to guide the exchange rate in a preferred direction. No one outside the central bank knows exactly how the formula is applied against the previous day’s price but it gives the authorities more room on the daily fixing and another weapon to counter the market mood.
Measures like these have helped to steer investors away from expectations that the renminbi was going to fall further and Chinese firms have been quick to get the message, switching their savings from dollars back into their own currency. Paul Mackel, head of emerging markets forex research at HSBC, says that many companies had built up large pools of dollars from trading surpluses. Some of the cash was diverted into paying off dollar-denominated debt or making investments overseas. But the remainder was kept as dollar deposits, which the firms are now trying to unload.
Chinese President Xi Jinping will welcome the yuan’s strength as a signal of confidence in the economy, which is politically important ahead of the 19th Party Congress set for October 18. The rally also points to an improved outlook over the medium term as fears about a ‘hard landing’ subside. But the capital controls and the intervention from the central bank send out conflicting messages at a time when the government is talking about further liberalising the exchange rate regime. “It’s getting further away from the goals [of free floating], especially after the counter cyclical factor was added into the daily fixing formula in May,” Zhang Ming, a researcher at the Chinese Academy of Social Science, told the South China Morning Post.
HSBC’s analysts take a more hopeful view, arguing that the stronger yuan offers a new starting point for reforms. The prediction is that policymakers will relax some of the measures that have restricted capital outflows over the past few months. But because these changes could lead to a “certain degree of RMB depreciation”, Beijing might also push for the redback to get stronger first in a “strategic prelude” to reforms next year.
The PBoC has indeed set the benchmark forex rate higher for 10 consecutive days and as of this morning the yuan had broken through the Rmb6.50 level to the dollar, hitting Rmb6.45. Mackel forecasts the rate to weaken to Rmb6.70 by the end of 2018 as the authorities move towards ‘clean floating’ and the capital account is further opened up.
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