Overall, a significant increase in the BBOP has been a major factor driving the RMB higher.
PBOC Favors Flexibility
In our view, the absence of PBOC intervention is less of a puzzle than it might appear. It’s been several years since the central bank took such action (for example, to defend the currency’s competitiveness in export markets), and it has explicitly disavowed plans to do so again.
The PBOC significantly increased the RMB’s flexibility in recent years, as a response to more volatile capital flows and to increase the independence of monetary policy. Partly because of this, CNY has been increasingly driven by market forces.
The PBOC does care about USD-CNY—but, rather than changing its direction or defending a “magic level,” the central bank is more concerned about the potential accumulation of pro-cyclical and speculative factors in the market, which could happen when the pace of appreciation or depreciation is too fast.
Importantly, direct intervention through foreign-exchange reserves has been sharply reduced, and the PBOC has preferred indirect policy tools such as macroprudential measures to curb the currency’s excesses.
All Things Considered, Stability Is Likely
Against this background, what is the short-term outlook for the RMB?
While all the above factors play a role, the most important, based on our research, is the BBOP. The current account surplus is likely to moderate this year, but we expect it to remain positive and significant. Foreign direct investment (FDI) inflows have trended upwards since 2015, despite a slowdown during the 2018–2019 trade war, and FDI data early this year together with industry surveys suggest they should remain steady.
Bond inflows could come under pressure from the geopolitical crisis and narrowing rate differentials, but the index-inclusion effect and potential increase in reserve allocation towards Chinese government bonds could help support flows. Equity inflows could benefit now that the government—following the equity market sell-off caused by macro policy uncertainties and the significant northbound equity outflow in early March—aims to improve communication with markets, policy coordination and transparency.
These factors, together with an expected improvement in growth fundamentals in coming quarters, should be positive for RMB.
Regarding yield differentials, while the 10-year US Treasury yield could rise further in coming months, we expect the comparable Chinese government bond yield to rise too, limiting scope for the yield gap to narrow further. Although narrower rate differentials could put some pressure on CNY, it is unlikely, in our view, to dominate its direction.
Taking all these factors into account, we expect the RMB to be broadly range-bound and stable against the US dollar in the short term.