Reasons for the appreciation of the Renminbi in this round and its impact on A-shares
The recent appreciation of the Renminbi is mainly driven by the decline in the US Dollar Index and the market's general expectation of a rate cut by the Federal Reserve. In addition, the drop in US technology stocks and the narrowing of the US-Japan interest rate differential have reshaped the strength of the Japanese Yen, thereby boosting the flexibility of the Renminbi. However, due to the insufficient fundamentals of the domestic economy, cautious observation is still needed for the sustained strength of the Renminbi exchange rate, and the market remains cautious about future trends
I. US Dollar Index Declines, Market Bets on Fed Rate Cut
Recent data on the US economy and employment show a significant cooling in the US labor market against a backdrop of sustained high interest rates. Federal Reserve Chairman Powell has sent a dovish signal, leading to global capital markets engaging in Fed rate cut trades.
II. Decline in US Tech Stocks, Narrowing of US-Japan Interest Rate Differential Expectations, Triggering Reversal in Yen Carry Trades, and Increased Renminbi Flexibility
1) Decline in US stocks triggers reversal in carry trades. Japan has long been in a low-interest and low-inflation environment, with the yen being highly liquid. The yen has become the main currency for global carry trades, where investors borrow yen to invest in higher-yielding US assets. Since July 11, the stock prices of US tech giants have experienced significant volatility, with the VIX panic index surging. The decline in tech stocks has also led to selling by trend trading funds, causing further price declines and a shift of funds to the safe-haven yen, reversing yen carry trades.
2) Expectations of narrowing US-Japan interest rate differentials strengthen. In March this year, the Bank of Japan raised interest rates for the first time since 2007, ending an eight-year negative interest rate policy. Stable inflation levels have provided conditions for further rate hikes by the Bank of Japan. In June, Japan's CPI and core CPI rose by +2.8% and +2.6% year-on-year respectively; in July, Tokyo's CPI rose by +2.2% year-on-year, while core CPI rose by +2.2%, meeting market expectations.
3) Both the Renminbi and Yen have characteristics of low-interest currencies, with the significant appreciation of the Yen against the US Dollar also driving the appreciation of the Renminbi exchange rate.
III. Assessing the Sustainability of Renminbi Exchange Rate Appreciation: Core Focus on Domestic Economic Fundamentals
Based on the analysis above, the decline in US stocks, reversal in carry trades, and appreciation of the Yen against the US Dollar have strengthened the short-term Renminbi exchange rate. The core of the Renminbi exchange rate trend still lies in domestic economic fundamentals. From the perspective of the Fed's monetary policy, despite a cooling labor market, there are currently no signs of severe recession in the data, and the US economy still shows resilience, making it inappropriate to excessively discount rate cut expectations. For China, after the central bank's rate cut, the Renminbi still faces pressure from the US-China interest rate differential inversion, and the future Renminbi against the US Dollar may shift to two-way fluctuations, while exchange rate flexibility may also increase.
IV. Enhanced Flexibility in Renminbi Exchange Rate Will Help Improve the Autonomy of PBOC's Monetary Policy
On July 19, the People's Bank of China held a meeting to convey the spirit of the Third Plenary Session of the Twentieth Central Committee, stating the need to "improve a managed floating exchange rate system based on market supply and demand, referencing a basket of currencies for adjustment, enhancing exchange rate flexibility, and maintaining the Renminbi exchange rate at a basic stable and balanced level." Currently, the Renminbi against a basket of currencies is relatively stable, and the future exchange rate flexibility of the Renminbi against the US Dollar may increase, which will help reduce the motivation for Renminbi carry trades, assist in hedging external uncertainties and shocks, and maintain the autonomy of China's monetary policy.
V. Impact on A-shares: Limited Impact of Exchange Rate Factors on the Stock Market
Since late May, the main A-share indexes have once again adjusted, with weak domestic demand and the continued bottoming out of the real estate market being the core reasons restricting investor confidence. Looking ahead, the insufficient macroeconomic resilience remains an objective fact at present. In terms of policies, the central bank has implemented interest rate cuts, while the National Development and Reform Commission and the Ministry of Finance have increased support for large-scale equipment upgrades and trade-ins for consumer goods, releasing signals of intensified efforts to stabilize growth, with the subsequent policy effects awaiting verification from high-frequency data. It is worth looking forward to the intensified efforts in the second half of the year to expand domestic demand and stabilize growth.
Author: Li Lifeng S1120520090003, Zhang Haiyan, Source: Li Lifeng's Strategy and Industry Allocation Notes, Original Title: "Li Lifeng, Zhang Haiyan: The Reasons for the Renminbi Appreciation in this Round and Its Impact on A-shares"