We wrote on the RMB in early February, when fears over the potential for a large, one-off devaluation were at their peak. We took a more constructive view, arguing that China’s policy makers – like policy makers elsewhere – are “learning by doing,” with the “devalue-pause-devalue-pause” pattern a way to explore how much devaluation is possible. The message they must have received is that easing China’s financial conditions through the exchange rate is potentially counter-productive, because RMB weakening spurs capital flight, tightening financial conditions, while currencies in the region also weaken, eroding competitiveness gains.
As a result, we argued that China’s policy makers would step back from fixing $/CNY higher, which would boost global risk appetite on fading devaluation fears. In line with our expectation, the SPX rebounded to 2000, though – counter to our view – EUR /$ has not fallen, nor has $/JPY risen, as markets continue to punish central banks that are seen to have a weak hand.
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With RMB devaluation fears now barely on the radar screen, we updates our take on the currency. We continue to think that the underlying story remains complex, where a rising current account surplus keeps reserve losses in check, even if capital outflows continue.
That said, risk-reward for hedging RMB devaluation is now much more compelling than earlier this year and makes sense to us, given our Dollar bullish view.