One-way appreciation carrying into the new year

• The RMB entered the new year on a very rapid appreciation as the USDCNH breached 6.35 for the first time since August 2015. A weak dollar is a large part of the story as the dollar index has declined 3.4% in 2018 but not all. The domestic environment is also supportive in terms of tamed capital outflows, robust exports and strong GDP growth.
• Interbank rates, especially 1M SHIBOR, softened significantly amid improved liquidity conditions in the beginning of the new year. The PBoC drained CNY350bn through OMOs in December to mop up the liquidity stemming from government deposits flooding into banks at year-end.
• However, liquidity was injected more generously since January.
• FX reserves built up to USD31140bn helped by a positive valuation effect as all major currencies appreciated against the USD and improved market sentiment. Capital outflows in terms of the FX positions held by banks / clients increased on the margin in December, which shows some preference for RMB by domestic private sector.
• We expect the current one-way appreciation to continue in the near term, but some correction of the currency should arrive in the next few months, due to the larger divergence between in monetary policy between PBoC and FED (as we do not expect the PBoC to fully transfer the FED hikes as what has been in the past few cases).

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