The onshore RMB fell below 6.5, down more than 2% in a single week, the second largest decline since the exchange rate reform in August 2015. However, it is worth noting that on Friday (April 22, 2022), the Shanghai Shenzhen Hong Kong stock connect recorded a rare net inflow (6.765 billion yuan) in the past week, and the Shanghai Composite Index closed red. How to understand the performance of exchange rate? In addition, it is worth noting that Yi Gang, governor of the people's Bank of China, made it clear in his speech at the Boao Forum that "the primary task of China's monetary policy is to maintain price stability". How to understand the meaning of exchange rate and market behind this sentence?
We believe that the rare sharp depreciation of the RMB this week has both the impact of macro expectations, but perhaps more importantly, the significant decline in the liquidity of the exchange rate market under the impact of the epidemic and the hidden dangers of trade credit have amplified this impact. We still believe that the pressure of RMB devaluation in the second quarter is too great, but such a sharp fluctuation is not normal.
Exchange rate depreciation is a double-edged sword. On the one hand, it helps exports, on the other hand, it may also bring imported inflation. In the context of the rise in commodity prices and the obstruction of production caused by the spread of the epidemic, the "inflation effect" of depreciation is greater. China will face the Impossible Triangle of exchange rate, inflation and stock market stability. To break the situation, we need to control the epidemic as soon as possible or the central bank should play more of the role of dollar provider.
On the impact of macro expectations, the Federal Reserve continues to play a "race" game with the market. Although we see that the core CPI of the United States has shown signs of slowing down month on month in March, what makes the Fed uneasy is that the market expectation for inflation is still rising, and the 10-year inflation expectation stands at 3%, at least reaching a high of nearly 20 years. In his speech on Friday, Powell basically confirmed the 50bp interest rate hike in May and was open to the same rate hike in the future. Affected by this, the market has begun to expect the fed to raise interest rates by 50bp in May, June and July respectively. We believe that under the "rush" strategy, the Fed's interest rate increase path will show the characteristics of "steep ahead and flat behind". The second quarter is the most extreme stage of poor expectations outside China.
Macro expectation is the catalyst, and the decline of market liquidity is an important driving force behind it. Since the spread of the epidemic in March 2022 and the closure of Shanghai, the volume of foreign exchange transactions has decreased significantly, which is likely to reflect the contraction of import and export trade. However, since Wednesday of this week (April 20, 2022), the spot trading volume of foreign exchange has rebounded rapidly and basically returned to the level before the spread of the epidemic and the same period in 2021. However, the current economy and foreign trade are not optimistic in terms of vehicle flow, freight flow, power generation in some areas or the throughput of the eight hub ports. Behind the data is that under the condition that the contraction of foreign trade has reduced the depth of the market, the amount of foreign exchange purchased by banks on behalf of customers has increased greatly, resulting in sharp fluctuations in the market.
Panic buying of foreign exchange? The impact on import enterprises is a greater hidden danger. According to the export data of South Korea in the first 20 days, China's import rate continued to decline in April 2022, but the volume of foreign exchange purchase increased significantly, which shows that the purchase of foreign exchange is not due to import trade. From the data of Shanghai Hong Kong stock connect, the performance of stock market funds is calm (Figure 2). Then there are two possible reasons: a large outflow of funds from the bond market; Or import enterprises panic buying foreign exchange (of course, it does not rule out some enterprises gambling on foreign exchange). In the current context, the latter may be more worthy of attention than the former.
We need to be alert to the positive feedback of import "deleveraging". Excluding some speculative funds, enterprises (mainly import enterprises) purchase foreign exchange mainly to repay trade credit or prepare for future imports. At a time when enterprises are facing the impact of epidemic and declining demand, the former should account for the main weight. Importing enterprises usually "leverage" when the RMB exchange rate is in the appreciation stage and enjoy the benefits of exchange rate appreciation through "trade credit + exposure non hedging" deferred payment. This is a story that has happened since the end of 2020. The same version has occurred before 2015 and 2017. However, once there is a sharp depreciation (or expectation) of the exchange rate, due to the lack of protection, importers will face huge exchange losses and panic purchase of foreign exchange in order to avoid the expansion of losses, resulting in the positive feedback of "depreciation deleveraging depreciation". This scene is likely to have been staged in the market this week.
The scale of importer's trade credit may not be smaller than that of bonds held by foreign investors. As of March 2020, foreign investors held 3.88 trillion yuan of inter-bank market bonds (about US $610 billion converted at 6.35). According to the statistics of safe, At the end of 2021, the trade-related credit balance of short-term foreign debt (within one year) was about 564 billion US dollars (this data may be underestimated. According to the regulations of safe, some trade financing business enterprises can choose whether to report, such as forward letter of credit within 90 days, overseas payment and other businesses, which is not uncommon). In terms of volume and cashing rigidity, compared with foreign debt holdings, trade credit will bring greater pressure on exchange rate depreciation.
More noteworthy is that this positive feedback mechanism is likely to increase China's inflationary pressure, resulting in an "Impossible Triangle" of exchange rate elasticity, inflation and asset prices. The devaluation of exchange rate, the rise of commodity prices and the sharp contraction of trade credit may lead to the "decline in volume and rise in price" of imports. At the same time, due to the closure of the epidemic, the role of exchange rate devaluation in promoting exports and production is greatly reduced, which will undoubtedly increase China's inflationary pressure. President Yi Gang's emphasis on price stability shows that inflation in 2022 is an important policy variable. In the second quarter of 2022, China may face the choice between exchange rate flexibility (non intervention), inflation stability and asset price fluctuation:
Scenario 1: maintain exchange rate flexibility and control inflation = asset price fluctuations rise. The central bank may choose the policy combination of "tight money and wide credit" - cautious liquidity investment, and increase the use of structural policy tools for targeted credit relief. Credit transmission takes time and resumption of work and production. This is not good news for stocks and bonds in the short term.
Scenario 2: control inflation input, stable asset price = control exchange rate or use external reserves. We should not only control inflation, but also maintain the stability of asset prices. The possible policy portfolio and monetary policy should continue to be loose. At the same time, we should regulate the exchange rate and cross-border capital flows or use external reserves to stabilize the exchange rate and imports, such as reintroducing the counter cyclical factor of exchange rate and reintroducing the risk reserve for foreign exchange long-distance purchase; Adjust the macro Prudential coefficient or implement stricter supervision and window guidance on cross-border capital flows; The central bank provides more dollar liquidity to the market. This is likely to lead to continued appreciation of the real exchange rate and help curb imported inflation.
Qingxing III: maintain exchange rate flexibility, stable asset prices = rising inflation. Similar to the operation of the Bank of Japan, in order to maintain the stability of China's asset prices (such as bond yields), increase water release. Without regulation, this will lead to a sharp depreciation of the exchange rate and a sharp rise in China's inflationary pressure.
We may be experiencing situation one, and the possibility of situation two is increasing. Under the background of globalization, scenario 1 may be our traditional mainstream means to deal with current economic contradictions, as evidenced by the frequent killing of shares and foreign exchange in several rounds of RMB devaluation cycles after 2015. However, after the epidemic, globalization has changed and the escalation of the conflict between Russia and Ukraine has made a qualitative change in the international situation. Taking the traditional road will only make China's economy and market bear more costs of international turmoil. Necessary intervention may be reasonable, such as strengthening the regulation of exchange rate and cross-border capital flows.
In the short term, foreign reserves will be used to ensure the stability of exchange rate and imports, and the cross-border use of RMB settlement will continue to be promoted in the medium and long term. Zoltan, a star analyst at Credit Suisse, advocated "Bretton Woods System III" in a series of recent reports, which is a long-term logic, but at least one point is very pertinent - the people's Bank of China with $3.2 trillion in foreign reserves is the breaker. In the short term, since the recent sharp fluctuation of the RMB exchange rate is due to the decline in the depth of the market, the people's Bank of China can use the US dollar in its hand to supplement liquidity for the market or market makers, so as to prevent the exchange rate from opening and closing widely, so as to wait for the return of trade capital flow after the resumption of work and production; Encourage banks to increase support for foreign trade enterprises, protect the stability of trade credit market and ensure orderly import; At the same time, we will increase open market operations to hedge against the reduction of base currency caused by the decline in foreign exchange, so as to ensure reasonable and sufficient liquidity.
In the medium and long term, expanding the scope of RMB settlement, constantly improving the cross-border settlement system and constantly improving the international status of RMB are the answers to get out of the above "Impossible Triangle" and the drag of the US dollar and the Fed cycle.
Risk tip: the spread of the epidemic exceeded market expectations, and the policy hedging economic downturn was less than market expectations
