Opinion

Too crowded bets on “7” for USDCNY could be dangerous

The Chinese yuan has been under pressure in recent days due to the slowing economy and, more importantly, the escalating trade war with the US. While the Peoples Bank of China has never said it will safeguard the dollar-yuan exchange rate against any particular level, many analysts have treated '7' as a magic number and heated debates have begun over whether the number is unbreakable.

By: Date: June 6, 2019 Topic: Global Economics & Governance

Chinese yuan has been under pressure in recent weeks due to the double dip in recent economic data and more importantly, the escalating trade war with the US. Since then, the CNY has shown weakness against USD, breaking 6.9 versus the USD, but also against major global currencies. The looming prospect of the China-US relationship, as well as a likely continued lax monetary policy in China, has all pointed to a weaker yuan, at least in the short term.

At this juncture, there is now a heated debate as whether it will hit “7” or, put it in another way, if “7” is an unbreakable magic number. So far, the market seems to believe that the PBoC has a floor on the USDCNY at “7”.

Is this really the case? We do not believe so.

To predict the behavior of the PBoC’s intervention, the first question is to ask is what the rationale behind the intervention is. In this round of intervention, the most notable reason to fend off depreciation could be to avoid the negative effect of rapid depreciation on accelerated capital outflow and business confidence, which could further drag down China’s already shattering economy. Based on the net reduction in US Treasuries holdings and the use of its countercyclical factor, the PBoC seems to have conducted sizable forex intervention to keep the RMB stable. But it is vital to note that China’s key concern is growth and RMB stability is increasingly important to achieve this goal but not a specific ceiling at “7”.

What’s more, bear in mind that the PBoC choose to safeguard the currency at the moment because it is benefiting to shore up investor’s confidence which has been affected by the escalating trade war. It may not always be the case. China’s exports have started contraction since November 2018, and an overvalued currency will only increase the unit cost for exports and thus harm export growth. The cost problem has been particular worrisome if the US further raises tariffs to more products importing from China. Once Chinese exporters start to feel more from the cost of exports and less from the sentiment, the PBoC will find it much reasonable to depreciate its currency, at least to temporarily offset the negative impact of the tariffs. Another big push which may change the behavior is the PBoC’s intention to weaponised exchange rate in the trade war with the US.

In fact, the PBoC has never announced any particular level that it wants to defend or explicit rule it is willing to follow, so the betting by the market analysts on 7 seems completely drawn from the belief in the “focal point”. This can be dangerous. In the context of China, history never guarantees any particular level for the RMB since the foreign exchange system reform in 2005. Yuan volatility against the USD has increased significantly after 2016, echoing the PBoC’s announcement to enhance the two-way volatility of its currency. In other words, the PBoC has definitely realised that any one-way betting on the CNY could only dampen its efforts to control the currency.

For the PBoC, safeguarding the currency is only to support growth and there is no reason to keep a magic number and sacrifice growth. This is especially so when the market started to bet on the number. This means that, although the PBoC is willing to push for the stability of the USDCNY, it would avoid wasting too many bullets to defend 7. The best strategy for the PBoC is to lean with the wind for forex intervention rather than against the wind, as the latter is clearly more costly. As such, the PBoC needs to introduce more two-way volatility. This is exactly what the PBoC did in early 2014 when it tricked the market by engineering a mini devaluation of the yuan against the USD against the background of a one-way bet for appreciation.

All in all, whilst the market is likely to see the PBoC intervening in the RMB market, we do not think “7” should be considered a ceiling. The objective of RMB stability is to avoid rapid capital outflows which could shake investor’s confidence. But to that end, the problem for the PBoC is not a fear of the magic number 7 but instead too crowded trades betting on the one-way movement of the RMB. Bear in mind that the PBoC has repeatedly remind the market about its higher tolerance of two-way movements in exchange rate. Relying too much on a specific point will only make it more difficult for the PBoC to discretionarily safeguard the foreign exchange market. If the investors start to speculate on one number, the PBoC will do its utmost to make them pay as it did in March 2014.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More by this author
 

Opinion

Why China should fear the EU's carbon border tax

Expect Beijing to soon start lobbying against the proposal.

By: Alicia García-Herrero Topic: Energy & Climate, Global Economics & Governance Date: July 26, 2021
Read about event More on this topic
 

Upcoming Event

Sep
2
11:15

Towards a new global trade regime: reform of the WTO

Bruegel Annual Meetings, Day 2 - the World Trade Organisation has been going through trying times, a phenomenon amplified by the pandemic. Why are we headed towards a new global trade regime? And what lies ahead for the WTO?

Speakers: Ngozi Okonjo-Iweala and Guntram B. Wolff Topic: Global Economics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
3
09:00

The role of the EU's trade strategy for an inclusive and sustainable recovery

Bruegel Annual Meetings, Day 3 - We are delighted to welcome Valdis Dombrovskis, Executive Vice President of the European Commission for An Economy that Works for People to talk about Europe's trade strategy.

Speakers: Valdis Dombrovskis, Alicia García-Herrero and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
2
14:15

Monetary and macroeconomic policies at the crossroads

Bruegel Annual Meetings, Day 2- In this session we would like to discuss monetary and macroeconomic policies after Covid-19.

Speakers: Grégory Claeys, Per Callesen, Gita Gopinath, Jorge Sicilia Serrano and Lawrence H. Summers Topic: Finance & Financial Regulation Location: PALAIS DES ACADEMIES, RUE DUCALE 1
Read article More on this topic
 

Blog Post

A world divided: global vaccine trade and production

COVID-19 has reinforced traditional vaccine production patterns, but the global vaccine trade has changed considerably.

By: Lionel Guetta-Jeanrenaud, Niclas Poitiers and Reinhilde Veugelers Topic: Global Economics & Governance Date: July 20, 2021
Read article More by this author
 

Blog Post

The European Union’s carbon border mechanism and the WTO

To avoid any backlash, the European Union should work with other World Trade Organisation members to define basic principles of carbon border adjustment mechanisms.

By: André Sapir Topic: Energy & Climate, Global Economics & Governance Date: July 19, 2021
Read article More on this topic More by this author
 

Opinion

Could the RMB dislodge the dollar as a reserve currency?

The dollar remains the world’s largest reserve currency, but it is facing both domestic and external risks.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: July 14, 2021
Read about event More on this topic
 

Past Event

Past Event

Strengthening the weak links: future of supply chains

What new supply chains trends will we see in the post-pandemic era?

Speakers: Ebru Özdemir, André Sapir and Guntram B. Wolff Topic: Global Economics & Governance Date: July 7, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

CCP's 100th Anniversary: Reflecting and looking forward

As the Chinese Communist Party celebrates its 100th anniversary, we looked into the past, future and present of the country's economic development.

By: The Sound of Economics Topic: Global Economics & Governance Date: July 7, 2021
Read article Download PDF More on this topic
 

Policy Contribution

Commercialisation contracts: European support for low-carbon technology deployment

To cut the cost of decarbonisation significantly, the best solution would be to provide investors with a predictable carbon price that corresponds to the envisaged decarbonisation pathway.

By: Ben McWilliams and Georg Zachmann Topic: Energy & Climate Date: July 1, 2021
Read article More on this topic More by this author
 

Opinion

What to expect from the ECB’s monetary policy strategy review?

Emphasis will be placed on greening monetary policy and clarifying the ECB's price stability objective, but is this enough?

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: June 23, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Avoiding a requiem for the WTO

The WTO has been 'missing in action': how can we restore the organisation's role as a global forum for cooperation on trade?

By: The Sound of Economics Topic: Global Economics & Governance Date: June 16, 2021
Load more posts