• The People’s Bank of China has set the USDCNY fixing above 7.20 for the first time since September 2023, and the market may interpret this as a green light for USDRMB to rise to 7.5 to offset the tariff impact.
• However, there are good reasons for China to defend 7.35-7.37 level too: medium-term EUR strength; exporters’ capability to pass on additional costs; likely additional fiscal and monetary easing in the near term; large onshore FX deposits and reserves; and an undervalued RMB REER.
• Despite the large uncertainty, we think the theme of a weaker RMB is unlikely to go away easily. We maintain a strategy of receiving 1y NDIRS vs paying 1y CNH CCS, as we expect a tightening of offshore RMB funding compared to onshore funding, which is likely to happen as China aims to ensure a soft peg or an orderly devaluation.
The People’s Bank of China set the USDCNY fixing at 7.2038 today, above 7.2 for the first time since September 2023. Some market participants may interpret this as a green light for a higher USDRMB, especially given that the market was expecting the PBoC to release some pressure on FX by devaluing the currency to offset the tariff impact. Given the scale of tariffs the US plans to impose on China, a gradual USDRMB move towards 7.5 could be acceptable to the international community. A move to the 7.5 level could be positive for corporate profits, as corporates have shifted to RMB financing and hold USD assets on their balance sheets.
Given the additional 34% tariff and China’s retaliation, we estimate that the fair value of USDRMB would rise to around 7.5, similar to our previous estimation. Previously, after the US election, we estimated that under a 60% tariff scenario, a ‘fair value’ for USDRMB would be 7.71 based on the multilateral exchange rate adjustment model {(1+13.9%*(60%-14%))*7.25}. and it would be 7.51 with China retaliation (see China FX: Answering five key questions on USDRMB post-US election, dated 14 November).
It is worth noting that the highest USDRMB fixing was 7.2555 delivered in November 2022, corresponding to a USDCNH spot high of around 7.3749 in October 2022. As such, instead of allowing a move towards 7.5, the PBoC could defend the currency around 7.37. These levels should be closely monitored, in our view.
Previously, the PBoC had kept the fixing below 7.20 and managed to keep the RMB stable against the USD amid the additional 10% tariff in both February and March, while the RMB has weakened against the basket as shown in the drop in the CFETS RMB index. The PBoC's preference was to keep the currency stable against the USD while allowing the currency to depreciate against the basket (mainly JPY and EUR), in our view (see Asia: Potential impact from US reciprocal tariffs, 4 April).
If the PBoC wishes to continue to defend the currency, we think the below arguments could support the central bank’s actions:
▪ Eurozone investors are currently structurally short EUR and a potential reallocation out of US equities could help the currency. We are also medium-term bullish on the EUR (see FX: MAGA to MEGA, dated 12 March). EUR strength is likely to lend support to the RMB, as it did last time around when Europe announced the aggressive fiscal plan.
▪ China's leadership anticipated the impact of US tariffs and has mapped out plans to respond, having accumulated experience since the 2018–19 trade war. Chinese authorities have been reiterating that they can cut the RRR and the policy rate at any time if needed. The government also plans to take measures to boost domestic consumption to reduce its reliance on exports, strengthen trade ties with non-US partners, stabilize the capital market, and support severely impacted industries and businesses. The equity market has already seen support from national funds and companies, such as the Central Huijin, following the plunge yesterday (see APAC equity derivatives update after ‘Liberation Day’, 7 April). There is also news that authorities are discussing property market support. The PBoC has also pledged to support these national funds with relending if they require more funding. The next key policy window to watch for China is the quarterly Politburo meeting at the end of April, which we think is the likely time for the authorities to announce major support measures.
▪ Chinese corporates may raise export prices to the US. We think Chinese exporters have the capability to do so with their price competitiveness. Passing tariff costs to US customers could increase the US's economic strain, potentially prompting both sides to return to the negotiation table, in our view.
▪ Onshore FX deposits have notably increased since last December (see China FX: Surging onshore FX deposits reflect FX policy tweak). The PBoC also holds large FX reserves. These could be utilized to stabilize the currency when needed.
▪ The US only accounts for 13.4% of China’s total exports and the USD accounts for 18.9% of the CFETS RMB basket. Given that the rest of the world accounts for 86.6% of China’s exports, it makes sense that the FX adjustment should reflect more in the basket. The RMB index has fallen on every tariff news this year, while USDRMB has been basically stable, making a lower RMB basket an effective shock absorber. Meanwhile, despite the recent decline in the RMB index, the divergence between RMB NEER and REER remains large, which suggests the RMB’s strong purchasing power can still mitigate some of the negative tariff effect and alleviate somewhat the depreciation degree.
The PBoC’s decision on whether to defend the currency is the key uncertainty going forward. We maintain a strategy of receiving 1y NDIRS vs paying 1y CNH CCS, as we anticipate some smoothing in offshore funding. This is inevitable, we think, as China aims to ensure a soft peg or an orderly devaluation, which should result in a tightening of offshore RMB funding compared to onshore funding. We will reassess this strategy once China delivers monetary easing and then shifts towards fiscal stimulus.
