By Chan Kung and Wei Hongxu*
Under the United States’ economic recovery and rising inflation expectations, the U.S. long-term Treasury yields have been rising continuously, and the U.S. dollar has reversed the depreciation trend began in the second half of last year. Due to the influence of the “taper tantrum” effect, the U.S. dollar has started to appreciate continuously, thus reversing the appreciation trend of the RMB. While the U.S. dollar has retreated in recent days after U.S. jobs data pointed to recovery and the government’s ongoing stimulus program, uncertainty about Fed policy amid strong inflation expectations will keep the greenback in a buoyant trend. The new changes in the global monetary environment in the post-pandemic period bring new challenges to the stability of the RMB exchange rate.
The RMB remains closely tied to the U.S. dollar, both in terms of historical data and the central parity rate of RMB. According to Reuters, the RMB was down 1.49% against the dollar in March, snapping a nine-month winning streak and posting its biggest monthly decline in 19 months. During the month, the U.S. Treasury yields continued to rise, leading to a strong dollar; the dollar index rose 2.59% in a single month and climbed above the 93 mark; the RMB depreciated 1.49% against the dollar to 6.5566. The onshore USD/RMB exchange rate also remained above 6.56 in April, before recovering slightly to 6.55 on April 6.
A recent analysis by ANBOUND cited the impact of rising inflation expectations in the U.S. on the dollar index as the main reason for the volatility of the RMB exchange rate. On the one hand, the new U.S. administration’s strong dollar policy has begun to be implemented. On the other hand, optimism about the U.S. economic recovery is driving back dollars, and the new U.S. administration is still rolling out new stimulus packages, which are contributing to rising inflation in the U.S. The data showed that the U.S. 10-year Treasury yield continued to rise and the narrowing interest rate differential between China and the U.S., which narrowed from a high of 250 basis points to 145, has put significant pressure on the RMB. In addition, the new U.S. administration is becoming more and more competitive with China, making the geopolitical tensions between China and the United States a new uncertainty factor in the RMB exchange rate. These factors will cause the exchange rate of the RMB against the U.S. dollar to fluctuate along with the trend of the U.S. dollar.
However, researchers at ANBOUND also noted that the impact of the “taper tantrum” of the U.S. strong dollar policy may lead to increased volatility of the RMB exchange rate and a trend of phase depreciation, but in the long term, the room for the RMB exchange rate to change is still limited. First, China’s economy has also maintained a strong recovery and growth momentum. Various leading data show that China’s economic growth in the first quarter will exceed expectations, which is the basis for the RMB exchange rate to achieve stability. At the same time, the moderate depreciation of the RMB exchange rate is conducive to the continued growth of Chinese enterprises’ exports to the U.S., which will relieve the pressure caused by the rising prices of raw materials. Second, some emerging economies are facing greater risk under the strong U.S. dollar, which to some extent makes international capital seek to allocate RMB assets to obtain relatively stable returns. China’s relatively stable monetary policy in the face of the Fed’s policy uncertainty has also helped in moderating the RMB’s depreciation.
Comparing the monetary policy since the COVID-19 pandemic with the monetary policy after the 2008 financial crisis, the monetary policy cycle of the Fed has become shorter and the range of policy adjustment has been larger. During the pandemic, the Fed cut interest rates to zero and implemented an unprecedented ultra-easing in a very short time. Just over a year later, the market participants are already talking about the Fed ending easing and starting to raise rates again. The Fed is expected to start raising rates in two years’ time, and should stop quantitative easing before then, meaning the policy will stay loose for about two years, significantly shorter than in the past. What worries the market more is that if inflation is higher than expected, the Fed is likely to end the easing early and accelerate the pace of interest rate hikes. Although in the long term, the influence of the dollar in the global economy is gradually fading, the dollar still has an important influence in the short term. In this case, the substantial policy changes of the Fed will not only bring volatility to the American economy and the capital market, but also impact the stability of currencies of various countries, including RMB. In fact, this change has been evident during the pandemic last year. The RMB exchange rate has experienced a large fluctuation from a high of 7.13 in May last year to 6.42 at the end of January this year, a significant fluctuation of more than 10%.
The new changes in the global economy in the post-pandemic period have made the international environment facing the RMB different from that of the past. From a global perspective, China and the U.S. are likely to continue their robust economic recovery. China has taken the lead in recovering due to better control of the pandemic and its strong economic resilience. The United States, with its faster vaccination, is expected to be the first to achieve herd immunity and thus a rapid recovery in economic activity. In other regions, slow vaccination and the spread of the pandemic continue to weigh on the economy. The IMF warns that in the post-pandemic period, the trend of divergence in the global economic recovery has become increasingly evident, with divergence not only among developed countries, but also between developed countries, emerging markets, and underdeveloped countries. In that case, even if the RMB depreciates against the dollar, it may still appreciate relative to other currencies. This will have an impact on China’s trade and investment with other countries.
As ANBOUND has pointed out, the stability of the exchange rate is actually a stabilizer for the entire Chinese economy. The new changes mean that China needs to consider a certain degree of “decoupling” of the RMB from the dollar to avoid being overly influenced by the dollar, which would hobble the Chinese economy under the monetary policy of the Fed. A recent People’s Bank of China (PBoC) working paper suggested that a global pricing mechanism for the RMB exchange rate should be considered under the new development pattern. The PBoC working paper emphasizes that, firstly, the role of various exchange rate derivatives on the formation of the exchange rate should be studied, the RMB exchange rate futures market should be established in due course, and the relevant domestic entities should be guided to effectively use the offshore futures market to avoid exchange rate risks. Second, it should strengthen the monitoring of global RMB flows, asset allocation, and price changes, improve the macro-prudential management system for RMB exchange rate risks, and steadily advance the internationalization of the RMB. Such attempts should be a new trend in geo-monetary changes, pushing for greater RMB independence.
Final analysis conclusion:
Global circumstances now imply that the factors influencing changes in the RMB exchange rate are different from those in the past. The international monetary environment, dominated by the U.S. dollar, and the post-pandemic economic environment will be different from the past. Such trend also points to a new direction in geo-currency evolution.
*Founder of Anbound Think Tank in 1993, Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
*Wei Hongxu, graduated from the School of Mathematics of Peking University with a Ph.D. in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing.