By Wilfred Wee, Portfolio Manager, All China Bond
Is this the end of the rout in the renminbi or is there further to go? All China Bond Portfolio Manager Wilfred Wee revisits recent developments and considers how Chinese authorities might react going forward.
After the fall, valuations cheap
Increasing US-China trade tensions saw the Chinese renminbi (CNY) depreciate by 8.4% from mid-June to a low of 6.935 against the US dollar in mid-August before recovering over 1.5% to c. 6.80 currently. On some valuation metrics, CNY is cheap, comparable to the levels of late 2016 when concerns over China growth were at their peak (Figure 1). Investors are now wondering where the currency may go from here and what action might Chinese authorities take as the situation develops.
Figure 1: Renminbi value rebased
Source: Bloomberg, 31 January 2014-31 July 2018.
Timeline of US China developments
It has been a noisy few months. The US and China have been engaged in tit-for-tat tactics on trade, unsettling both emerging and most developed markets. This triggered a bout of CNY weakness from the middle of June when the US ratcheted-up trade tensions by formally identifying the first set of Chinese goods to be targeted:
Table 1: Timeline of US-China trade dispute
|22 March||Trump announces plans to impose tariffs on up to $60bn of Chinese goods.|
|4 April||US Trade Representative (USTR) announces list of $50bn of Chinese goods. China responds in kind.|
|5 April||Trump orders the USTR to consider additional tariffs on $100bn of Chinese goods.|
|18 - 19 May||High-level talks with US Treasury Secretary Steven Mnuchin, Commerce Secretary Wilbur Ross and USTR Robert Lighthizer, and China Vice Premier Liu He; China agrees to significantly increase purchases of US goods to reduce trade imbalances.|
|29 May||White House announces a final tariff list of $50bn of Chinese goods to be revealed by 15 June.|
|6 June||China offers to buy $70bn of US products in exchange for, and conditional upon, the removal of tariffs.|
|15 June||US publishes list of $34bn of Chinese goods at 25% tariffs, $16bn to be reviewed. China quickly follows suit on 16 June, while also backing out of previous agreement to significantly increase purchases of US goods.|
|18 June||Trump threatens 10% tariffs on $200bn of Chinese goods, another $200bn if China retaliates.|
|6 July||US tariffs on $34bn of Chinese goods at 25% take effect. Chinese follow suit.|
|10 July||USTR announces list of $200bn of Chinese goods.|
|1 August||Trump orders USTR to consider raising tariffs on $200bn of Chinese goods from 10% to 25%.|
|3 August||China announces plan to impose tariffs on $60bn of US goods at 5%-25%.|
|20 August - 5 September||USTR holds public hearings on $200bn tariffs.|
|22-23 August||Low level talks between US Treasury Under-Secretary David Malpass and China’s Vice Commerce Minister Wang Shouwen yield no results.|
|23 August||US tariffs on $16bn of Chinese goods at 25% take effect. Chinese follow suit.|
China’s export and import growth data for July surprised to the upside, despite the tariffs between China and the US kicking-in
The economic impact of the measures on trade so far is not yet obvious. In fact, China’s export and import growth data for July surprised to the upside, despite the tariffs between China and the US kicking-in earlier in the month. While still very early days, China’s trade surplus against the US in July actually increased by 11.3% year-on-year, rather than moderate.
China’s policy responses
Chinese authorities are clearly aware of the risks to the economy from the trade tensions. Alongside the depreciation of the CNY were domestic monetary, regulatory and fiscal policy easing measures aimed at countering potential trade headwinds.
Table 2: Loosening policy measures taken by the Chinese authorities in the second quarter
|1 June||People’s Bank of China (PBOC) expands Medium Term Lending Facility eligible collateral to include lower rated (AA+ and AA) corporate bonds.|
|14 June||PBOC refrains from following the Fed’s rate hike, relaxes loan quotas for select commercial banks.|
|24 June||PBOC announces 50bps cut in Reserve Requirement Ratio (effective 5 Jul) to support small and medium size enterprises (SME) lending and debt-for-equity swaps.|
|Late July||China’s banking regulator (China Banking and Insurance Regulatory Commission (CBIRC)) encourages banks to better serve SMEs, lower financing costs, and softens restrictions on wealth-management products. State Council meeting calls for accelerated issuance of local government special bonds for infrastructure development, calls for looser fiscal policy.|
However, the pace of depreciation then led to concerns that currency weakness could destabilise regional markets and business sentiment. Moreover, the fall had obviously not gone unnoticed in the White House, threatening to aggravate further the standoff between the US and China.
Following verbal suasion against CNY pro-cyclical market behaviour in July, from early August, the authorities explicitly moved to prop up the currency. In early August the 20% reserve requirement for banks selling CNY FX forwards to clients was re-imposed. Similarly, the PBOC Q2 Monetary Policy Committee (MPC) report reiterated that currency weakening is not a tool to address trade frictions.
In recent weeks there have also been reports of a tightening in FX transactions in the free-trade zones (with the aim of increasing the cost of shorting CNY). Meanwhile, on the 24 August, the PBOC confirmed the return of a counter-cyclical factor in setting the daily morning US dollar-renminbi midpoint fix, with the aim of mitigating recent pro-cyclical sentiment on currency depreciation. A line seems to have been drawn in the sand, but for how long?
In the short term, how the trade situation with the US pans out will have a significant bearing on the CNY. While there could be some agreement before meetings between Trump and Xi at the upcoming Asia-Pacific Economic Cooperation (APEC) and G20 summits in November – we feel this is overly optimistic. More likely in our view is that trade relations remain a long, drawn out and contentious issue, given the strategic issues at play between the two economic super powers. Moreover, we expect anti-Chinese rhetoric to remain a key plank of Trump’s campaigning in the lead up to the US midterm elections in November.
Table 3: Key upcoming dates for US-China trade
|5 September||Public hearings on $200bn of Chinese goods conclude, final decision possibly a week later.|
|October - November||US tariffs on $200bn of Chinese goods could take effect. Chinese tariffs on $60bn of US goods could take effect.|
|6 November||US midterm elections.|
|12 - 18 November||APEC meeting; Trump and Xi to meet.|
|30 November - 1 December||G20 Summit; Trump and Xi to meet.|
The official media has markedly toned down its rhetoric and stopped using provocative phrases
China’s reaction going forward
It is undoubtedly in China’s interests to de-escalate current tensions. In recent weeks, Chinese authorities seem to have moved towards more restrained reaction from their earlier robust tit-for-tat retaliations.
The official media has markedly toned down its rhetoric and stopped using provocative phrases like “we will take powerful measures”, which it did in the beginning. The most recent currency measures would also seem to suggest an inclination to not have currency weakness obstruct any potential engagement with the US. Meanwhile, amid unpredictable US trade policy, the Chinese authorities are likely to focus on supporting domestic demand. This may be through conventional monetary policy, but especially likely through upgrading tax and industrial policy.
In recent years, the Chinese economy has rebalanced away from an investment-led growth model towards greater dependence on household consumption and services. Policies to bolster growth in these areas hold the key to achieving broad stable economic growth.
In the medium-to-longer term, the support for CNY ultimately lies in improved productivity and investment prospects in China. To this, the pursuit of stable growth conditions, economic upgrading and transformation, and continued market-oriented reforms are key. We see these remaining well-entrenched in the current Chinese administration.
Conclusion: risk of further depreciation limited
We still see little indication of a quick resolution to the US-China trade spat. However, we think the risk of further CNY depreciation is limited. The destabilising impact of further depreciation on the domestic economy would see the authorities act to support the currency. We can see this in the moves by the authorities to re-apply the counter-cyclical adjustment factor. Moreover, any further significant depreciation will only serve to worsen relations with the US. Indeed, we think China – perhaps taking some comfort from progress made on US-Mexico trade talks – will try to take a more accommodative approach to trade negotiations.
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All rights reserved. Issued by Investec Asset Management, issued August 2018.