Xiaocun Qiu and Huixuan Li
- For the first time in two years, the USD/CNY rate broke 7 on September 16. Since March 2022, the CNY has depreciated by more than 11% against the USD amidst a continuous strengthening of the latter (Figure 1). During the same period, the US Dollar Index increased by nearly 15%, while the CNY's nominal effective exchange rate (NEER)–which measures its value against a basket of currencies–depreciated by less than 1% (Figure 2).
Figure 1. US Dollar Index appreciates more than CNY depreciates against USD
Figure 2. CNY NEER and REER depreciated by a small margin
- The fact that the US interest rates went higher and China's rate lower has driven the CNY to depreciate against the USD. The US 3M Bond Yield increased from 0.1% p.a. at the beginning of this year to nearly 3% p.a. in September, whereas the 3M Interbank Offered Rate in China fell from 2.5% to 1.6% (Figure 3). It marked the first "inversion" between the two rates since the 2007 Global Financial Crisis.?
Figure 3. For the first time since mid-2007, US short-term interest rates exceeded those in China
- In addition, the slowdown of the Chinese economy has led to the CNY’s weakening. The COVID lockdown policy has impaired production, suppressed household income growth, and reduced investment returns, resulting in capital outflow pressure.
- Nevertheless, due to China's strict capital controls, it isn't easy to move funds out. Besides, China witnessed strong export growth: year-to-date, exports have increased by 14% YoY, and the trade surplus has grown by 58% YoY (Figure 4). As a result, foreign currency supply has exceeded demand, pressing the CNY to strengthen. As the appreciation factor partially offsets the depreciation pressure discussed above, the CNY depreciated less against the USD than many other currencies.
Figure 4. China registered a large trade surplus in 2022
- The future trend of USD/CNY depends primarily on economic conditions and monetary policies. In a speech in late August, Powell emphasized that the current focus is to bring inflation back down to the 2% goal, and the Fed will raise the policy rate "until the job is done" (Figure 5). In contrast, the Chinese economy is presently in a situation where the government tends to stimulate domestic demand and boost the economy through monetary easing.
Figure 5. Fed will continue to raise interest rates amidst record-high inflation
- A growing number of economists (e.g., those from Goldman Sachs and JP Morgan) are anticipating a "soft landing" of the US economy–which has been our primary argument this year. If the country continues to grow at a reasonable pace, the USD will likely remain strong. Meanwhile, institutions, including the IMF, have lowered their forecasts for China's GDP growth and believe its high export growth rate is unsustainable. Under such circumstances, the CNY will continue to depreciate. However, strict capital controls in mainland China may prevent some capital outflows and ease the depreciation pressure to a certain extent.
