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 communication@bruegel.org.

View comments
Read about event More on this topic

Upcoming Event

Jun
19
12:30

What reforms for Europe's Monetary Union: a view from Spain

How is a successful European Monetary Union still possible in today's ever-shifting political landscape? What reforms need to occur in order to guarantee success of cohesive policies?

Speakers: Fernando Fernández, José Carlos García de Quevedo, Gabriele Giudice, Inês Goncalves Raposo, Javier Méndez Llera and Isabel Riaño Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Jun
20
12:30

Sound at last? Assessing a decade of financial regulation

What has changed since the financial crisis of 2008 that makes the financial system sound at last? Is regulatory reform going in the right direction? Has it run its course? 

Speakers: Patrick Bolton, Rebecca Christie, Maria Demertzis, Mathias Dewatripont and Xavier Vives Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Jun
24
08:30

China’s investment in Africa: consequences for Europe

How is Chinese investment impacting Africa, and what could be the consequences for Europe?

Speakers: Solange Chatelard, Maria Demertzis, Alicia García-Herrero and Abraham Liu Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More on this topic

Working Paper

China and the world trade organisation: towards a better fit

China’s participation in the WTO has been anything but smooth, as its self-proclaimed socialist market economy system has alienated its trading partners. The WTO needs to translate some of its implicit legal understanding into explicit treaty language, in order to retain its principles while accommodating China.

By: Petros C. Mavroidis and André Sapir Topic: Global Economics & Governance Date: June 13, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director’s Cut: A strategic agenda for the incoming EU presidents

In this Director’s Cut of ‘The Sound of Economics’, Bruegel’s Guntram Wolff and Maria Demertzis talk through their memo to the new presidents of the European Commission, Council and Parliament, outlining the specific measures that should be implemented in order to tackle the most formidable challenges arising in the next five years.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: June 12, 2019
Read article More on this topic More by this author

Blog Post

The inverted yield curve

Longer-term yields falling below shorter-term yields have historically preceded recessions. Last week, the US 10-year yield was 21 basis points below the 3-month yield, a feat last seen during the summer of 2007. Is the current yield curve a trustworthy barometer for future growth?

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: June 11, 2019
Read about event More on this topic

Upcoming Event

Jul
12
09:30

The 4th industrial revolution: opportunities and challenges for Europe and China

What is the current status of EU-China relations concerning innovation, and what might their future look like?

Speakers: Elżbieta Bieńkowska, Chen Dongxiao, Eric Cornuel, Ding Yuan, Jiang Jianqing, Pascal Lamy, Li Mingjun, Signe Ratso, Reinhilde Veugelers, Wang Hongjian, Guntram B. Wolff and Xu Bin Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

The 'seven' ceiling: China's yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: June 3, 2019
Read article More on this topic More by this author

Opinion

Expect a U-shape for China’s current account

As the US aims to reduce it's bilateral trade deficit, China's current-account surplus is back in the headlines. However, in reality China’s current-account surplus has significantly dropped since the 2007-08 global financial crisis. In this opinion piece, Alicia García-Herrero discusses whether we should expect a structural deficit or a renewed surplus for China's current-account.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: May 28, 2019
Read article Download PDF More on this topic

External Publication

Europe – the global centre for excellent research

This report, requested by the European Parliament's Committee on Industry, Research and Energy, analyses the EU’s potential to be a global centre of excellence for research as a driver of its future growth in a complex global S&T landscape, and how EU public resources can contribute to this.

By: Michael Baltensperger and Reinhilde Veugelers Topic: Innovation & Competition Policy Date: May 22, 2019
Read article More on this topic

Blog Post

India in 2024: Narendra Modi once more, but to what end?

Even with the recent economic slowdown, India still boasts Asia’s fastest growing economy in 2018. But beneath the veneer of impressive GDP expansion, uneasiness about India’s economic model clearly tempers enthusiasm.

By: Alicia García-Herrero and Trinh Nguyen Topic: Global Economics & Governance Date: May 17, 2019
Read article More on this topic More by this author

Blog Post

What is in store for the EU’s trade relationship with the US ?

If faced with a resurgent President Trump after the next US election, the EU will have some difficult decisions to make as it is compelled to enter a one-sided negotiation. Failure to strike a deal will imperil the world’s largest trade relationship and contribute to the progressive unravelling of the rules enshrined in the World Trade Organization – although the changes required of Europe by Trump’s demands may ultimately turn out to be in the interest of Europeans.

By: Uri Dadush Topic: Global Economics & Governance Date: May 16, 2019
Load more posts