It includes resistance in FX policy.
The RMB’s strong performance has caught the market's attention, as since early June, the RMB has been a top performer, not only against major currencies struggling with low inflation and low yields, but also against most EM currencies.
According to a research note from HSBC Global Research, looking forward, monitoring the following key factors to anticipate whether the RMB’s strength could reverse would be needed.
These factors include FX policy possible turning more resistant. The large August trade surplus may change the ‘balanced’ FX flow conditions seen since April.
Such strong USD supply may help correct exporters' over-hedging and importers' under-hedging issue from earlier (recall outstanding net short USD forwards positions stood only at USD24bn at end of July).
Here's more from HSBC Global Research:
This would allow exporters to resume selling USD FX forwards but limit importers buying USD FX forwards. This scenario could cause the USD-RMB curve to stop steepening, which in turn would reduce the appeal of long RMB positions from a carry perspective.
Outright USD selling interest would lead to a significant rebound of FX inflows, including ‘hot money’ inflows. If such flows were to be seen, it could lead policymakers to induce more volatility into the exchange rate, and create some headwinds for the RMB as they did earlier in the year.
A significant softening in China's export data. The recent rebound in China's trade surplus has been an important support for the RMB. However, we note that the increase is mostly from weaker imports rather than strong exports.
With the RMB now appreciating against the currencies of most of China’s trade partners, we could see China's exports turn softer at some point as these are still sensitive to the exchange rate.
We recognize this could take some time to emerge considering that the trade surplus tends to show some seasonal strength going into Western holidays at year-end.
A change in monetary policy from current targeted easing to outright easing. Our economists still believe that outright easing in China's monetary policy will be needed at some point, as the growth recovery remains uneven.
While this may not completely alter the RMB's interest rate advantage, it does carry some significance considering the Fed is set to hike next year.
A significant pick-up in Overseas Direct Investment (ODI) and outward individual investment.
China's ODI has regained momentum since Q2. In July, non-financial ODI exceeded FDI for the first time on record, rising to USD9.2bn in the month.
With China relaxing ODI (for instance, the latest ODI rule to be effective on 3 October 2014) and individual outward investment policy to encourage outflows (e.g. Shanghai-Hong Kong Stock Connect), these capital outflows are set to pick up to help to offset inflow pressures over the medium term.
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