The RMB is not pegged to the USD: Too crowded bets on “7” could be dangerous

• As Chinese yuan weakened to the 10-year low, heated debates have sparked over whether “7” is an unbreakable magic number. The strength of the dollar, as well as a laxer monetary policy in China, has all pointed to a weaker yuan. But the market also seems to believe that the PBoC has a floor on the USDCNY at “7”.
• Is this really the case? We do not believe so. Although the PBoC continued the use of its countercyclical factor and even some possible intervention by selling USD to keep the RMB below 7, China is also under pressure to stimulate the economy. The latter goal requires an even lower interest rate, which is likely to push the RMB weaker. Furthermore, with the implementation of tighter capital control measures since 2015, it is very hard to restrict further without hurting real transactions. In a nutshell, the PBoC is now facing a dilemma between growth and exchange rate stability.
• Given the increasingly lax policy stance, we believe growth will be the priority and exchange rate will be in the backseat. First, the objective of stable currency is to provide an accommodative environment to support the economy. There is no reason to keep a magic number and sacrifice growth. Second, even if the PBoC wants to keep its exchange rate target, it does not mean “7” is a fixed limit, especially when the market started to bet on the number. Relying too much on a specific point will only make it more difficult for the PBoC to discretionarily safeguard the foreign exchange rate market.
• All in all, while the PBoC will not allow a free fall in the RMB, we would suggest the market to look beyond any single number, such as “7”, especially when China acts opposite to the FED and continues its massive liquidity injection into the market. The PBoC is wary of one-way bet on the RMB, and a crowded trade on a specific point could be increasingly risky for investors.

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