More CNY Weakness Ahead – Danske Bank
Allan von Mehren, Chief Analyst at Danske Bank, suggests that Chinese growth has shown signs of stabilisation and we look for moderate recovery during 2016 driven by the construction sector, which was experiencing a hard landing over the past year.
“Home sales have moved higher and inventories of unsold houses have come down. Consumption growth remains robust. After severe depreciation pressure, CNY sentiment has improved after China drew a line in the sand in January by pushing up CNH (offshore) money market rates. We look for the PBoC to cut policy CNY rates over the next 3-6 months to ease the debt burden for Chinese companies and underpin continued robust growth in home sales.
FX policy. China has made two important changes to policy over the past year First, the daily reference rate has become more market based. Second, the CNY is now explicitly managed against a basket of currencies rather than just the USD. The change in system coupled with equity market turmoil caused considerable confusion and capital outflows at the beginning of 2016. However, capital outflows eased considerably in February and March and CNY has strengthened again versus the USD. While strengthening against the USD the CNY has weakened against the basket.
Valuation. Despite the CNY’s appreciation in recent years, we do not regard it as overvalued as 1) China’s share of global export markets continues to improve; and 2) China still has a robust current account surplus of 3% of GDP.
Risks. There is still a risk that the CNY could depreciate faster if capital outflows pick up again on mounting bank losses or if the economy weakens further.
The PBoC managed to calm the markets faster than expected and the depreciation pressure on CNY versus the USD has eased. We have thus lowered our forecast slightly but still see a 5% depreciation over the next 12 months to 6.85 (a bit weaker than the forward market). We still look for CNY to weaken, though, on divergence in monetary policy between the US and China. The CNH-CNY spread has been eliminated again after the depreciation pressure eased. We expect the spread to stay around zero throughout the forecast horizon. Hence any basis risk in hedging CNY exposure through CNH is expected to be limited.”
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