Fed rate cut, trillions of dollars flowing back, will the RMB surge by 10%?
The proponent of the "Dollar Smile Theory" predicts that a US rate cut could trigger a $1 trillion inflow of Chinese funds, driving the RMB to appreciate by 10%. As the year-end corporate settlement peak approaches, CICC expects that $10 billion in settlements will support an RMB appreciation of around 10%. By late July, many exporters are choosing to "settle immediately after receiving payment"
Since mid-July, the Renminbi has been rising all the way, approaching the 7.1 mark at one point. Has the Renminbi entered a period of appreciation? Analysis suggests that with the approaching rate cut by the Federal Reserve and the release of corporate foreign exchange demand, the Renminbi may enter a window of strong upward movement.
Renowned proponent of the "Dollar Smile Theory" Stephen Jen boldly predicts that a rate cut in the United States could trigger a $1 trillion inflow of Chinese funds, leading to a 10% appreciation of the Renminbi. As the interest rate differential between China and the United States narrows, Chinese companies may convert their foreign exchange into Renminbi.
In addition to the emotional catalyst brought about by "rate cut trades" and the reversal of yen carry trades, the peak of year-end foreign exchange settlement by enterprises is also affecting the Renminbi's trend. A research report by CICC predicts that foreign exchange settlement demand of around $10 billion could theoretically support a Renminbi to US dollar exchange rate (appreciation) of around 10%.
The Renminbi's appreciation is reversing the pattern of corporate foreign exchange settlement. Several export company executives have stated that since late July, as soon as they receive US dollars, the company immediately converts them into Renminbi.
Trillion-dollar Inflow, Proponent of "Dollar Smile Theory": Renminbi Could Surge by 10%?
Recently, Stephen Jen, Chief Executive Officer of the UK hedge fund Eurizon SLJ Capital and a well-known proponent of the "Dollar Smile Theory," stated that with the rate cut in the United States, Chinese companies may sell $1 trillion worth of US dollar-denominated assets, potentially leading to a Renminbi appreciation of up to 10%.
Jen said, "The Renminbi will appreciate, and it is likely to be allowed to appreciate - for China, an appreciation of 5% to 10% is moderate and acceptable." He predicts that since the outbreak of the pandemic in 2020, Chinese companies may have accumulated over $2 trillion in funds from overseas investments, most of which have been invested in higher-yielding US dollar assets.
Jen believes that the attractiveness of US dollar assets will gradually diminish, prompting some Chinese companies to convert these US dollar assets into Renminbi. Especially against the backdrop of a narrowing China-US interest rate differential, there may be a $1 trillion inflow of funds into China, thereby driving a significant appreciation of the Renminbi.
The rate cut by the Federal Reserve is now a certainty. Federal Reserve Chairman Powell clearly stated at the recent Jackson Hole central bank annual meeting that the time for a rate cut in the United States has come, almost confirming the rate cut plan in September. According to Jen, this will provide an excellent opportunity for the Renminbi to appreciate.
Jen's views align with those of Guan Tao, Chief Economist of BOC International. Last week, Guan Tao mentioned in an interview that international market volatility could lead to a rapid appreciation of the Renminbi due to exporters' foreign exchange settlement and the unwinding of carry trades. He stated that the Fed's preemptive rate cut will help stabilize the Renminbi exchange rate, and once the Renminbi appreciates by 3% to 4%, market interest in US dollar interest rate differentials will greatly diminish.
Year-end to See Peak of Corporate Foreign Exchange Settlement, CICC: $10 Billion Settlement Scale Will Support Renminbi Exchange Rate by 1000 Points
In a research report, CICC analyzed that behind the recent strong appreciation of the RMB, in addition to the rise of the yen and the reversal of carry trades bringing about emotional catalysts, another widely speculated factor is corporate forex settlement. At the end of the year, corporations will face a peak in forex settlement. If the accumulated demand for settlement is released in a concentrated manner, the RMB appreciation will be supported. Settlement of around $10 billion will support a 1,000-point or 10% appreciation in the RMB exchange rate.
CICC stated that in the first half of this year, the USD was relatively strong, leading to a lower willingness of Chinese corporations to settle forex. Data shows that the proportion of export settlements over the past year has been trending downwards, from a peak of 54% to a recent low of 44%. However, it is important to note that the willingness of corporations to settle forex is strongly correlated with the exchange rate, hence there is significant cyclical volatility. Once the RMB exchange rate expectations stabilize, there is a possibility of the previously accumulated USD forex being settled again.
According to CICC's calculations, the potential monthly USD funds that corporations may settle range from $8 to $14 billion. Firstly, assuming that the decrease in settlement willingness this year is only a temporary disturbance and will return to the previous central level, the size of funds temporarily waiting due to exchange rate depreciation is around $14 billion on average per month. Secondly, assuming that the change in settlement proportion this year is trend-based but with overshooting, this portion of monthly funds is around $8 billion.
CICC stated that if the above-mentioned funds choose to settle, the short-term support for the RMB exchange rate may be around 1,000 points (10%). The RMB exchange rate tends to be stronger at the end and beginning of the year, and weaker in the middle of the year. This seasonal trend may be related to the peak in corporate forex settlement at the end of the year. Therefore, an increase in short-term settlements can provide certain support to the exchange rate. When the RMB exchange rate is regressed against the difference in export settlement, the two show a certain negative correlation. Model results show that a demand for settlement of around $10 billion can theoretically support the RMB against the USD at around 1,000 points.
Rate cuts boost corporate forex settlement, Morgan Stanley: RMB may usher in a period of appreciation
Morgan Stanley stated that as of July 2024, the settlement proportion of Chinese exporters is at a historical low of 13.5%. This means that for every $100 of export income received, Chinese corporations only convert $13.5 into RMB. To increase the settlement proportion, the USD to RMB exchange rate may need to drop to 6.9 or 6.8, depending on further rate cuts by the Federal Reserve.
With the narrowing of the US-China interest rate differential, the demand for Chinese exporters to convert USD into RMB is increasing. Morgan Stanley predicts that the RMB may enter a period of outstanding performance. In the first 7 months of 2024, the settlement in the trade balance was only $84 billion, while the settlement scale over the past six years has typically been between $95 billion and $180 billion In addition, the domestic demand for RMB purchases is growing rapidly, and exporters are also becoming optimistic about the future appreciation of the RMB