Negative market sentiment on CNY may not abate quickly

The renewed rise in FX deposits highlights the increasing currency pressures and the ongoing monetary dilemma that China is facing. 

Even though the authorities have kept USDCNY fixings broadly stable and have attempted to tame market expectations of policy changes through public comments, these efforts have failed to calm market expectations of CNY depreciation. 

This is reflected by a number of factors, including the rise in FX deposits, offshore USDCNH trading above the upper bound of the onshore USDCNY trading band, and the extreme skew in risk reversals in the FX options market. 

Barcalys notes as follows:

• We do not see these factors abating; indeed, we expect USDCNH to continue to trade above USDCNY, with the risk that the basis will widen further. 
  
  
• As the USD has risen against global currencies, the market has likely become more concerned that China eventually will have to allow more CNY weakness versus the USD in order to tame REER appreciation. 
  
  
• As we argued in CNY: Deflation, downturn and the deepening monetary dilemma, 12 February, amid slowing inflation and rising outflows, the costs of limiting CNY weakness are growing - including the unintended effect of placing more stress on CNY market liquidity and interest rates, rendering liquidity easing efforts less effective