There are more reasons to see RMB appreciation than continued depreciation

The rapid depreciation of RMB has been worrying the market, especially against the backdrop of the trade war and the Turkey crisis, which have prompted a more negative sentiment on the emerging market asset class. We have been holding the view that rapid RMB depreciation would be halted by the PBoC. We would now like to add that, on the face of a more accommodating fiscal stimulus (supported by laxer monetary policy), we are more likely to see RMB appreciation than depreciation. 

The most important factor guiding international capital flows, namely the China-US yield differential, has narrowed significantly since the end of the 2017 to a historical low since early 2016. However, fiscal stimulus should push interest rates up. While the PBoC may instill liquidity to support the market, the FED hiking cycle puts additional upward pressure on interest rates in China.

Moreover, the recent actions from the PBoC, such as use of countercyclical factor and the imposition of reserve requirement for forward transactions, suggest that a fast depreciation is not desired by the PBoC. Considering that China still holds massive foreign reserves and a very tight command of the banking sector, it should be possible for the monetary authority to redirect the RMB in its desired direction.

All in all, we believe that the wave of RMB depreciation is probably over and that renewed fiscal stimulus will bring a halt to decelerating growth as well as higher interest rates supporting a stronger RMB.

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