Every investor wants to find a one-way bet. And for many, the closest thing has been the Chinese renminbi.
For years, we’ve seen the renminbi rise slowly but steadily against the US dollar. Even at the peak of the global financial crisis, it remained solid while all other currencies were falling.
But it may be time to reassess. In the last few days, something unusual has been going on that should at least warn investors that nothing – not even a rising renminbi – is a sure thing…
How the renminbi exchange rate works
The People’s Bank of China (PBoC) fixes the renminbi-dollar exchange rate, setting a reference rate and allowing it to trade up to 0.5% above or below that each day. (By “fixes”, I mean the PBoC implements exchange rate policy on a day-to-day basis. The president and politburo decide the wider strategy of how fast the renminbi should rise.)
If you look at the exchange rate in recent days, there’s little to worry about. The renminbi has been steady to slightly rising against the dollar over that time.
But intraday, there’s been much more action. The renminbi has several times fallen the maximum permitted 0.5% against the dollar, with the PBoC intervening to support it and bring it back up to the reference rate.
This is extremely unusual. Normally, the PBoC has to intervene to prevent the renminbi from rising too much. Even back in 2008-2009, the currency didn’t come under sustained selling pressure like this.
What’s behind this? Is it a sign that China’s economy is faltering?
Not really. We already know that China is slowing – most of the data is saying this. Even inflation now seems to be rolling over; consumer price inflation was 4.2% year-on-year in November, from 5.5% in October.
The authorities know this and are already loosening monetary policy. Reserve requirements – the amount that banks have to hold with the central bank, to restrict their rate of lending – have already been cut (reserve requirements and ‘guidance’ on what and where to lend are much more important for monetary policy than interest rates in China).
But there’s no suggestion that China is collapsing, so the weakness has little to do directly with those kinds of fears. Instead, smaller trade surpluses combined with hot money flowing out of the economy are probably behind the change.
Get ready for greater volatility
Does this mean that the renminbi is going to depreciate? Given that most analysts have long taken appreciation for granted, this is definitely a contrarian question worth asking. Indeed, one noted contrarian, Société Générale’s bearish strategist Albert Edwards, has long argued that a serious China slowdown will see renminbi depreciation in an attempt to support exporters.
I think significant depreciation is highly unlikely. There are certainly factions in the Chinese government who would like to see it happen; the pro-exporter Ministry of Commerce dislikes currency appreciation at the best of times and would presumably be happy to see it go into reverse.
But most senior policymakers would take the view that the exchange rate is a difficult enough issue in US relations anyway and allowing a major depreciation would make things very awkward. In addition, China is trying to move up the value chain and would prefer that exporters gain advantages through better practices and greater efficiency than a cheaper currency, so other forms of support seem more likely, if needed.
However, there is a good chance that the renminbi will become more volatile. As the currency moves closer to fair value and is no longer so substantially undervalued, the more we would expect it to trade up and down, even if the long-term trend is still up.
Look at other emerging market (EM) currencies that trade more freely to see this. While the long-run trend for most EM currencies – certainly in Asia – is likely to be up against developed world ones, the last few months have shown us that they still sell off hard at times of crisis.
Recently, the renminbi has not done this due to the extent of the undervaluation, the size of the trade surplus, the strength of the peg and investors’ confidence in the Chinese economy. If any of these are changing, more volatility is likely.
A jittery renminbi could be bad news for bonds
It’s unlikely that China is deliberately trying to make the renminbi weaker or more volatile at the moment. But at the same time, policymakers probably don’t mind if it happens.
They would prefer not to have the headache of hot money flows from speculators gambling on the ongoing rise in the currency. If it made the market a bit less confident that the renminbi can never go down, that would probably be all to the good.
For long-term investors, it doesn’t make that much difference. If you don’t believe that a big depreciation is coming – and I still don’t – some shorter-term volatility won’t have any impact on your returns.
Is it time to bail on ‘dim sum’ bonds?
However, there is one area where investors might be right to be rattled. I’ve written before here about the growth of the dim sum bond market: renminbi-denominated bonds issued offshore in Hong Kong and available to foreign investors.
As you may remember, these trade at very low rates – below equivalent rates on the mainland – because investors are betting on getting renminbi appreciation as well as interest to boost their returns. But if that appreciation is no longer such a sure thing in the shorter term, some of those yields look quite miserly.
Average yields have already risen from around 2% to around 4% over the last few months, on concerns about the weaker quality of many borrowers and the prospect of increased supply of new issues. A jittery renminbi is the last thing this market needs.