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Maybank: Depreciation Pressure Should Ease After Yuan Fixing
Aspire | 20 August 2015
By: Lim Si Jie
Articles (169) Profile

Once again, China has managed to send shocks to the financial markets. People’s Bank of China (PBOC) stopped supporting Chinese Yuan (CNY)’s tight link to the US dollar, allowing CNY to weaken by three percent through Friday. While it is not large by foreign-exchange standards, the yuan devaluation unsettled global financial markets that are worried about weak global growth and deflation pressures. (Note: Japan’s yen has fallen by 35 percent since 2012)

Depreciated, Not Devalued

Since PBOC used a new methodology to fix its USDCNY mid-point, USD/CNY has gapped up for two consecutive sessions in a row, reached a high of 6.4489 on Wed (12 Aug) and closed at 6.4005 (13 Aug).

Under PBOC’s new system to set the daily fixing, market makers are required to submit their exchange rate quotes based on

  1. Closing prices of foreign exchange rates on the previous day,
  2. Supply and demand conditions in the foreign exchange market as well as
  3. Moves in major currencies.

While some may view that CNY is being devalued consecutively for three days, analysts share the view that CNY has depreciated, not devalued on the 12th and 13th of Aug. Apart from the de facto first devaluation on 11 August, the rest of the USDCNY mid-point “fixing” is pretty much “market-determined”.

PBOC wants to drive across the point that the CNY fixing should be more market determined. The International Monetary Fund, which is considering adding the yuan to its basket of reserve currencies, said that the mechanism should allow market forces a greater role.

FX Forecast Changes

Source: Maybank Kim Eng

CNY: Change in Regime, Revamp in Forecast

Maybank expects further downside pressure on the CNY against the USD amid weak fundamentals, and plenty of room for further monetary easing juxtaposed against a US economy that is on track for recovery. Maybank will revise its 3Q forecast to 6.50, taking into account the upcoming Fed hike. However, Maybank is also expecting some strength to return to CNY as global growth gains traction.

JPY: Still Poised For Further Drop

The USD/JPY temporarily spiked above 125 in reaction to the USD/CNY rally but has since reversed back to below 125 as safe-haven flows came into play. Maybank’s forecast is kept status quo as they continue to expect the Bank of Japan to add to its ultra-loose monetary policy given that the two percent inflation target is unlikely to be achieved by 1H FY2016.

MYR: Ringgit Downside Pressure Continues

The downside pressure on MYR is due to a combination of both domestic and external risk factors. This includes possible Fed tightening in Sep leading to USD strength, pick-up of financial market volatility arising out of China’s slowing growth, oil price volatility (remains above historical average) and falling oil prices (down 25% to US$50/bbl, from year high in May), as well as ongoing political/ contingent liability risks affecting foreign investor sentiment.

Against a backdrop of falling FX reserves (approximately 31% decline from its peak in 2013 to $96.7 billion in Jul 2015), Malaysia remains vulnerable to external economic shocks. Malaysia’s ratio of reserves to short term external debt, and import cover are at 1.05 times (vs. 1.3 times in end-2013) and 6.6 months (vs. 8.1 months in end-2013), respectively. Both indicators of reserve adequacy are also the lowest in the region.

SGD: Further Weakness Ahead

The trade/financial links of Singapore to China were exposed when the USD/CNY was fixed at sharply lower on 11 Aug. The de-facto devaluation of the CNY vs. the USD and its subsequent climb sent the USD/SGD to a multi-year high of 1.4165 on 12 Aug as foreign investors sell-off the short-end of Singapore government debt papers.

Moreover, Maybank’s Uncovered Interest Rate Parity (UIP) model suggests that the SGD remains overvalued, which could prompt further adjustments to the pair. The adjustments are already taking place as reflected in the 3-month Singapore Interbank Offered Rate (SIBOR), which is up to 0.9345 (as of 12 Aug) from the recent low of 0.8155 percent on 9 Jul.

The weaker growth in 2Q, the downward revision to full-year GDP growth, and the spike in the USD/SGD, amid the disinflationary environment, has prompted speculation of further monetary easing in Oct.

Expect Reserve Requirement Ratio (RRR) Cuts and Band Widening

Maybank’s analysts expect this bout of CNY depreciation and further CNY depreciation expectations to see further capital outflow which could tighten liquidity and increase the need for RRR cuts. Analysts forecast another 100bps of RRR cuts to ease liquidity while trading band could be widened to +/- three percent in the next two months. The spot rate for USD/CNY has now converged towards the fixing, signalling some form of calm returning to the FX market. The market should expect less depreciation pressure on the yuan from a band widening unlike the previous two episodes.

Where Will CNY Go From This Point?

CNY weakness should linger as China continues to face short-term economic pressure whilst embarking on capital account liberalization. In the longer term, yuan will inevitably strengthen simply because of its current account surplus and strong growth pace relative to its regional peers. PBOC even stated that the “yuan will enter appreciation path in the future”.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.


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