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The strength of CNY can be traced to three factors: the rebound in real GDP, higher commodity prices (which has aided the reflation theme and reduced pressure on the banking system) and higher interest rate differentials.
Only the PBoC can stop the CNY appreciation. The market has to accept this unpleasant fact, I’m afraid. Over the past weekend, the PBoC announced that it has abolished the reserve requirements for FX forward purchases, effective today. It was introduced in October 2015 and set at 20% to increase the costs of USD purchases and provide some support for CNY at the time. This underpins that the fact the depreciation pressure on CNY has diminished significantly.
The CNY continued to fall after the reserve requirement and the decline broadly matched movements in other currencies against the USD. Capital outflows through outward FDI and cross border banking flows were sizeable and the main drivers of currency weakness. But the measures probably did help to contain the risks, even though onshore CNY forward volumes (buy and sell dollars) only temporarily declined.
According to Bloomberg, citing people familiar with the matter, “the PBoC will cut the cash set aside by financial institutions when buying dollars for clients through currency forwards to 0% from 20%”, effective September 11.
The CNY has been appreciating at a torrid pace, posting its best 3-month performance ever (4.5%). The dollar is down across the board but the CNY is outperforming – the CFETS basket is up 2.5% in the past six weeks and has reversed the entire depreciation from late last year.
There should be an impact on the forward market (points and the shape of the curve).
Prior to the 20% reserve requirement, onshore forward points and CNY NDF (and CNH) points were closely aligned and so were spreads (1x6, 3x12 for example) in all three markets. After the regulations, 6m and 12m points started to diverge (onshore points were depressed relative to CNY NDF and CNH points). Also, the onshore curve has been more flat compared to the others.
Onshore forward points could rise (all else equal) and CNY NDF points (and CNH) could fall given some companies can access multiple curves, though demand for long dollar hedges would be suppressed when the RMB is strengthening. Over time, forward points and the shape of the curve across these markets could become more aligned if the reserve requirement does drop to 0%.
