RMB breaks 7.29 again

Recently, the Chinese yuan has fallen to a new low against the US dollar this year, once breaking below 7.29, causing a strong market reaction. Although the fundamentals of the yuan are not weak, due to the widening interest rate differential between China and the US, the yuan faces significant depreciation pressure.

This situation has attracted close attention from all parties, as the fluctuation of exchange rates will directly affect export prices, which are closely related to the production costs of a large number of industries; at the same time, the prices of imported goods will also rise or fall accordingly, which will affect the profitability of major multinational corporations. So, in the coming period, which direction will the yuan's exchange rate fluctuate?

The basic stability of the yuan is supported

Recently, the continuous decline in the yuan exchange rate has caused a lot of market turmoil. Seeing the exchange rate approaching 7.3 day by day, it is inevitable to think that although China's economic fundamentals seem quite stable, why is the yuan under pressure? This matter is actually not simple, and there are many factors at work behind it.

China's economy, although the growth rate has slowed down a bit in recent years, compared with many developed countries and emerging markets, China's economic growth is still quite good.

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In 2024, the global economic growth is expected to reach a level of 3.2%, among which the emerging markets, which are self-evident in importance, will have an increase of up to 4.2%, and China's actual economic growth rate is expected to maintain at around 5%, which is an excellent overall performance.

On the other hand, if we focus on the manufacturing level, it is not difficult to find that China's manufacturing purchasing manager index (PMI) has surpassed the US for 17 consecutive months, which undoubtedly proves that in the field of manufacturing, the gap between China and the US has not been further expanded, but highlights that China still has strong competitive strength in this field.

As for inflation, since the outbreak of the epidemic, China's inflation rate has always been at a relatively low level. Low inflation usually means stable currency purchasing power, which makes Chinese goods and services more attractive to foreigners. In theory, this should be conducive to the appreciation of the yuan exchange rate.

Another important point is the performance of the current account. China's trade surplus in goods is very large, which means that China is a net earner in the global market, which is a positive support for the exchange rate. Especially since the second half of last year, China's export growth has steadily recovered, which is usually a precursor to exchange rate stability.Despite the favorable fundamental conditions, the renminbi exchange rate still faces depreciation pressure. One of the reasons is the widening interest rate differential between China and the United States. Currently, the interest rates in the United States are relatively high, and many investors, in pursuit of higher interest earnings, have transferred their funds from the Chinese market to the U.S. market. This arbitrage behavior has increased the depreciation pressure on the renminbi.

Although China has controls on capital flows, there are still some ways to conduct carry trade transactions. For example, some enterprises with the qualification for foreign exchange settlement and sale can hedge exchange rate risks by adjusting the settlement ratio or choosing to use swaps instead of spot transactions for foreign exchange sales.

These operations, while not directly impacting the spot market, reduce the supply of foreign currency in the market, indirectly putting pressure on the renminbi exchange rate.

However, we cannot ignore the massive debt that the United States has to pay. This issue is like a time bomb, which could trigger fluctuations in the global financial market at any time. If the U.S. debt problem erupts, it would be a test for the global exchange rate market.

The Fed's Interest Rate Cuts "Weaken"

Recently, the depreciation of the renminbi exchange rate is undoubtedly closely related to the slowdown in the Federal Reserve's interest rate cut decisions. This has led to a certain degree of disappointment in the financial market that had expected the Fed to implement multiple interest rate cuts this year. Just over a month ago, global investors generally believed that the Fed would carry out at least two large-scale interest rate cuts this year, with the expected reduction exceeding 50 basis points.

However, to this day, the market's expectations for the Fed's interest rate cuts have undergone a significant change. It now appears that the Fed is only likely to carry out a single interest rate cut of 25 basis points, or it may even abandon the interest rate cut plan altogether.

This huge gap in expectations has led investment institutions on Wall Street to adjust their forecasts for the frequency of the Fed's interest rate cuts. They generally believe that the number of interest rate cuts by the Fed this year will be far lower than previously expected.

This directly affects the market's view on U.S. Treasury yields. People now generally expect U.S. Treasury yields to return to their peaks, allowing the dollar's interest rate advantage to be maintained for a longer period.The recently released report by the U.S. Department of the Treasury on international capital flows reveals that in April of this year, the overall scale of U.S. government bonds held by foreign investors showed a回调 trend compared to the previous month, with a reduction of up to $66.3 billion, and the total holding amount was fixed at $8.018 trillion.

During this period, after five consecutive months of growth, foreign investment strategies for U.S. bonds have shown a downward trend for the first time, among which Japan, Canada, and the United Kingdom, which are among the top ten holding countries, have particularly significant reduction efforts.

Considering multiple factors such as geopolitical situation and inflationary pressure, these factors have driven the yield of U.S. government bonds to rise gradually to varying degrees.

Taking the 10-year U.S. government bond as an example, after experiencing market fluctuations in April, its yield has risen by nearly 20 basis points, which has further widened the interest rate gap between China and the United States, and the inversion phenomenon has become more serious.

These trends have not only affected the bond market but also caused the renminbi exchange rate to continue to decline since June 6. However, some industry observers have pointed out that although the current situation seems to be that the renminbi exchange rate against the U.S. dollar is declining, there may actually be an overshoot phenomenon.

Looking at the latest data, although the U.S. dollar index has fallen compared to the highest value of 106.5 reached on April 16 this year, it has now fallen to 105.85; however, the renminbi exchange rate against the U.S. dollar has fallen from the original 7.24 to the current 7.28.

This seems to imply that the recent renminbi exchange rate may have experienced an "overshoot" phenomenon, and market sentiment may have overreacted to some changes in economic indicators.

The risk in the United States is more serious.

What will the next step of the renminbi exchange rate against the U.S. dollar be?The director of the State Administration of Foreign Exchange, Zhu He, recently stated that China's foreign exchange market is robust enough for the renminbi exchange rate to remain stable at a reasonable level. He summarized several reasons, referred to as "three mores": a more solid economic foundation, a significantly enhanced market resilience, and rich and profound experience in crisis management.

Let's discuss the economic fundamentals. Currently, China's economic development still maintains a good momentum, and in the medium to long term, various positive factors are growing stronger.

Therefore, both domestic and overseas investors, including those from abroad, would undoubtedly make a wise and stable long-term decision by including the renminbi and Chinese assets in their investment portfolios.

Zhu He further emphasized at the conference that in the future, the advantages of the policy toolkit will continue to be leveraged to effectively prevent excessive fluctuations in the renminbi exchange rate and potential risks brought about by abnormal cross-border capital flows.

So, what about investors?

The overall trend has not changed, and investors still need to focus on and increase the implementation of strategies to allocate non-US dollar assets. The reason is that renminbi assets have attracted many investors due to their excellent risk-avoidance capabilities, stable returns, potential long-term investment value, and good liquidity.

On the policy level, government departments will continue to strengthen regulation of the foreign exchange market and capital flows to achieve a rational and balanced market state.

However, speaking of the United States, the situation there is a bit tense.

By 2024, the total federal debt of the United States has approached 35 trillion US dollars. This number is alarming to hear, and the speed of debt growth is simply astonishing, increasing by nearly 1 trillion US dollars every quarter.The current high-interest-rate policy in the United States may seem to alleviate urgent short-term needs, but in the long run, the government's interest payments will increase dramatically, placing a huge burden on the economy.

The U.S. Treasury Department has no choice but to engage in a cycle of borrowing new money to repay old debts, but this is fundamentally an unsolvable vicious circle.

Against this backdrop, countries holding U.S. debt have begun to worry that America's debt problems could trigger global financial market turmoil, affecting their own economic security. Therefore, reducing holdings of U.S. debt and lowering risks seem to have become their inevitable choice.

However, at this moment, some American media have begun to accuse China of having more severe debt problems, trying to shift the focus. This smear campaign obviously cannot cover up the severity of the U.S. debt problem.

In summary, the government is confident and has strategies to maintain the stability of the future trend of the RMB exchange rate. At the same time, the U.S. debt problem is like a sword hanging overhead, which could trigger a larger crisis at any time.

At this time, investors naturally need to have keen eyes to discern which side is risk and which side is opportunity.