General

On May 31st, the onshore and offshore RMB exchange rates fell below 7.1!

In the eyes of industry insiders, the RMB exchange rate has continued to decline since mid May, mainly due to various factors. Firstly, the expectation of further interest rate hikes by the Federal Reserve has increased, causing the US dollar index to rebound to 104.51; Second, the recent upside down of China US interest margin (the yield margin of 10-year Chimerica bonds) has expanded to 93 basis points; Thirdly, some northbound funds have been profiteering since May, and fourthly, the demand for foreign exchange settlement by international trade enterprises has weakened.

The RMB dropped below the 7.11 level

On May 31st, the offshore RMB and onshore RMB fell below the "7.1" level. The decline of the offshore RMB against the US dollar widened to 416 points at 7.1315 yuan, setting a new low since November 30, 2022.

The onshore RMB closed at 7.1065 against the US dollar at 16:30, a decrease of 164 basis points from the previous trading day.

In the past half month, the exchange rate of the Chinese yuan against the US dollar has mostly remained above "7", which is the second time since the end of last year that the Chinese yuan has broken below "7".

Double fell below 7.1! What is the reason?

In the view of industry insiders, the lower than expected PMI of domestic manufacturing in May and the early rise of the US dollar index may be the trigger for the RMB exchange rate to fall below 7.1. The underlying reasons are the repeated expectations of the Federal Reserve's interest rate hike in June and the continuation of the weak recovery pattern of the domestic economy.

It is not clear that the Federal Reserve will suspend interest rate hikes in June

Zhou Ji, a macro foreign exchange analyst at the South China Research Institute, said that the market had previously tended to believe that the probability of the Federal Reserve raising interest rates in June was not high. However, recently, it has significantly raised expectations for a rate hike in June, causing the US dollar index to break through the 104 mark, putting pressure on the Chinese yuan exchange rate.

The repeated market expectations stem from the internal entanglements and disagreements within the Federal Reserve. As of now, the Federal Reserve has raised interest rates 10 times in a row, raising the US federal funds rate to between 5% and 5.25%, marking the first time since 2006 that it has risen above 5%.

The consequence of radical interest rate hikes is that since March 2023, the banking crisis in the United States has continued to ferment, and as of now, four banks, including Bank of America, Silicon Valley Bank, Signature Bank, and First Republic Bank, have successively failed. US public opinion believes that further aggressive interest rate hikes may fuel the crisis ridden US banking industry and bring the country closer to recession.

Former US Treasury Secretary Summers also believes that US inflation seems to be in a dilemma of 4.5% -5%, which is more than twice the Federal Reserve's 2% target.

Given that the Federal Reserve has raised interest rates ten times in a row and the banking crisis has had a less than expected inhibitory effect on the economy, this means that the Federal Reserve may have to further raise the federal funds rate to alleviate price pressure.

The pattern of weak economic recovery continues

Bank of China Securities Global Chief Economist Guan Tao recently wrote that this year, due to the decline in US inflation and banking turmoil, the Federal Reserve's interest rate hike is gradually coming to an end. This means that the impact of overseas factors on the RMB exchange rate is weakening, and changes in domestic economic fundamentals may have a greater impact on the trend of the RMB exchange rate.

On the 31st, according to data released by the National Bureau of Statistics, in May, the manufacturing procurement manager index, non manufacturing business activity index, and comprehensive PMI output index were 48.8%, 54.5%, and 52.9%, respectively, lower than the previous month's 0.4, 1.9, and 1.5 percentage points.

Zhao Qinghe, senior statistician of the Service Industry Survey Center of the National Bureau of Statistics, explained that China's economic prosperity level has dropped, and the foundation for recovery and development still needs to be consolidated.

Wu Wei, a researcher at the China Logistics Information Center, said that the short-term fluctuations in the market will not change the long-term stable and rapid recovery trend of China's economy. With the continuous increase of policies related to stabilizing investment, promoting consumption, and stabilizing employment, the new demand momentum will gradually accumulate.

In the second half of the year, with the further release of investment and consumer demand potential, a stable economic recovery can still be expected.

Will it continue to decline after breaking '7'?

In the medium to long term, the Federal Reserve's interest rate hike is nearing its end, and the overall downward trend of the US dollar index is unlikely to change. The external pressure faced by the renminbi will ease; From a domestic perspective, the RMB exchange rate, supported by factors such as international balance of payments surplus and improved fundamentals, does not have the conditions for trend depreciation.

From a comprehensive market perspective, although the onshore and offshore RMB has once again broken the "7" mark in intraday trading, it has not changed the supporting force of the medium to long-term RMB value.

As for the subsequent trend of the RMB exchange rate, Zhang Ming, Deputy Director of the Institute of Finance at the Chinese Academy of Social Sciences, believes that it can be viewed with optimism. He pointed out that with the strengthening of the recovery efforts, the overall growth rate of the Chinese economy will be upward, while the US economy will generally decline under the continuous interest rate hikes.

The growth gap between China and the United States will widen, and the growth gap is currently more important in determining exchange rates than interest rate differentials. Therefore, Zhang Ming predicts that there may be a relatively mild appreciation of the RMB against the US dollar in the second half of the year, which may reach around 6.5-6.6 by the end of the year.

Zhou Ji, a macro foreign exchange analyst at the South China Research Institute, added to reporters that in May, the demand for foreign exchange purchases due to dividend payments by Chinese enterprises gradually emerged. According to statistics, the depreciation pressure brought by Chinese enterprises' foreign exchange purchasing behavior on the RMB exchange rate is most obvious from May to June each year.

In his opinion, there is no need to worry too much about this seasonal factor. The current low willingness to settle foreign exchange originates from the high interest rates of the US dollar. However, as the US economy is no longer able to withstand multiple rounds of significant interest rate hikes, the process of interest rate hikes is gradually coming to an end, leading to the expected narrowing of the US China interest rate gap, thereby boosting the willingness of enterprises to settle foreign exchange and providing support for the RMB exchange rate.

Wang Qing, Chief Macro Analyst of Dongfang Jincheng, judged that in the short term, the RMB's "breaking 7" trend may continue for a period of time, but the possibility of breaking the previous round of 7.32 low is unlikely.

Wang Qing predicts that in the second half of the year, as the domestic economic recovery process continues, and other influencing factors are taken into account, the RMB/USD exchange rate may experience a slight appreciation of around 2.0% year-on-year by the end of the year, which is a slight increase from 6.95 at the end of last year to around 6.8.

He stated that the current round of RMB/USD exchange rate breaking 7 is more a result of normal fluctuations in the foreign exchange market. In the future, regulatory authorities may moderately guide market expectations and prevent excessive aggregation of the "herd effect" in the foreign exchange market by strengthening market communication and other means. However, as in September last year, it is not necessary to intervene through policy measures.

How will international trade export enterprises benefit from the RMB exchange rate breaking 7 again?

The depreciation of the RMB often benefits export-oriented enterprises in international trade:

1) The depreciation of the RMB can lower the price of domestic products compared to foreign products, enhance product competitiveness, and obtain more orders;

2) The appreciation of foreign currencies leads to an increase in settlement prices, corresponding to an increase in RMB income in the financial statements and an increase in gross profit margin;

3) International trade export-oriented enterprises often own some US dollar assets (such as monetary funds, accounts receivable, etc.), and the exchange gains generated by exchange rate fluctuations are included in financial expenses, affecting the current net profit.

There is a positive correlation between the profitability of export chain enterprises and the exchange rate between the US dollar and the Chinese yuan. We selected 22 export chain companies in the light industry sector. Except for Zhejiang Yongqiang's use of forward foreign exchange contracts to lock in exchange rate losses, they recorded good net exchange earnings in 2022, with Yingqu Technology having the highest net exchange earnings of 140 million yuan in 2022. Analyzing the relationship between gross profit margin, net profit margin, and exchange rate, we found that in the years when the US dollar/RMB exchange rate was high (2019, 2020, 2022), companies in the export chain sector generally had better profitability, with the most significant improvement in financial expenses in Q2 and Q3.

For international trade export enterprises, depreciation is certainly a positive factor, but large trade enterprises tend to lock in exchange rates in advance to reduce the risk of market fluctuations, so the impact is not significant. For small and medium-sized enterprises, the scale of trade is small and it is usually not suitable for risk hedging, which is easily affected by exchange rate fluctuations. The benefits of depreciation are limited, and for traders, maintaining a relatively stable exchange rate can bring long-term benefits.

Facing the increasingly frequent fluctuations in the global exchange rate market, accelerating the process of RMB internationalization may be the optimal solution. At present, the proportion of Chinese enterprises using financial derivative products to avoid exchange rate risk is still not high, because using corresponding tools requires a certain cost, which is difficult to bear for low profit labor-intensive industries in the middle and low end. However, with the transformation and upgrading of China's industrial structure and the accelerating pace of RMB internationalization, the impact of exchange rate fluctuations on Chinese enterprises will gradually decrease Lian Ping, Chief Economist and Dean of the Research Institute of Zhixin Investment, said.