China: The Falling Yuan and Stock Market

Published on August 10, 2018

With the yuan having plunged against the dollar by almost 7% since June to 6.85 from around 6.40, analysts have embarked on a new round of speculation over when and whether the Chinese yuan will break below what is assumed to be the psychologically important level of 7.00, especially in light of the ongoing and fluid trade tensions between Beijing and Washington. 

*** The People’s Bank of China and economic leadership team in Beijing remain sanguine about the (“market-driven”) fall in the yuan. From what we understand, if anything, the PBoC would not mind seeing the CNY continue to gradually weaken, as long as those movements are not overly volatile. ***

*** But for now, in a very telling turn of phrase, officials note that “in the current context of a China-US trade war” the 6.80-6.90 area could be an ideal range for the currency to stabilize. That, interestingly, is a range pausing around current lows, and not stronger. ***

*** And along those lines, in an even more pointed turn of language, officials in private note that, all else being equal, the State Council and PBoC will not want the yuan to break through the 7.00 level “until” the US imposes tariffs on $200 billion of Chinese imports. The choice of the word until rather than if the US imposes another round of tariffs is in and of itself interesting – whether, as appears on the surface, an indication of expectations of the inevitability of the next major round of escalation, or whether as a more diplomatic phraseology to what would be the more openly threatening alternative word choice of “if.” *** 

*** Regarding China’s equity markets, officials emphasize that valuations are at two-year lows even as over 70% of listed firms have reported double-digit net profits in the first half of 2018. Much of the fall in Chinese equity markets, clearly, is attributable to fears of a trade war between China and the US, as opposed to, by implication, more serious issues with the domestic Chinese economy or financial system. ***

Beyond an effort to reassure, the key message is that the stock market drop this year is fundamentally different from the drop in 2015, and thus will not necessarily elicit the same policy response.

Assessing the Fallout

Senior Chinese economic officials note they have seen limited outflows, if any, from the recent drop in the CNY – indeed PBoC data shows a modest rise in China’s FX reserves over the last two months.

And while the FX volatility to date has hurt, or at a minimum coincided with, weakness in the stock markets, the feed through of stock market weakness into the real economy is small, and it does not appear to be nearly enough to offset potential benefits of a weak CNY on the export side.

They furthermore stress that the top priority of China’s monetary and fiscal policy is and will always be the management of the real economy, employment, state-owned enterprises, and prevention of major financial risks. Stabilizing the stock market is not, and has not been, a priority for the State Council or PBoC, unless faced with emergency situations such as the crash in the summer of 2015, when the State Council ordered the CSRC (Chinese Securities Regulatory Commission) and relevant departments to take emergency actions.

In a measured assessment of the current situation, senior officials note that financial risks in China are much lower now than they were three years ago, starting with leverage rates that are lower. They furthermore indicate they are certain that the growth of shadow banking assets and Non-Performing Loans (NPLs) will remain constrained in the second half of 2018, and expect the size (and by implication risk) of interbank assets, interbank wealth management products, and investments via special purpose vehicles to shrink further.

From what we understand, despite all that, the National Team has been persistently increasing the size of their A-Share holdings, as have QDII investors, particularly since June.

But as things stand, Chinese officials expect China’s economic momentum and enterprise profits to stay on course through the second half of 2018, and economic data in July to come in on par, if not even slightly stronger, than in June.

And with liquidity now relatively abundant, they see no need for a universal RRR (Reserve Requirement Ratio) cut … “at least this month.”

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