Hao Hong: “Chill” about CNY Beyond 7

  • The CNY weakness reflects deteriorating global fundamentals.
  • Shadow CNY suggests further USD strength and corresponding CNY weakness.
  • A weakening CNY augurs for looming global risks. Stay put.

Weakening CNY explained by fundamentals

Finally, the CNY has weakened past the threshold of 7. The divergence of the Fed and BoJ at the Jackson Hole summit has heralded the epic US dollar strength and JPY/EUR weakness. As the gap between 2-year US treasury yield and the Fed fund rate is around its widest in history, and the US inflation rate is peaking but likely to linger higher and longer, the Fed is unlikely to stop its tightening campaign.

Figure 1: As FX reserve & deposits fall, CNY depreciate

Source: Bloomberg, GROW Research

Besides the divergence between global central banks, the changes in fundamentals in the Chinese economy have contributed to the weakness in the CNY as well. One of the economic puzzles in 2022 has been that Chinese exports continue to stun pundits, yet all these exports have failed to translate into rising forex reserve. Even if we include the forex deposits in commercial banks, we are still confronted with a picture of declining forex accumulation (Figure 1).

Exchange rate changes of the assets held in the forex reserve, as well as some capital outflow in the first half of the year are not enough to explain falling forex accumulation on the back of strong exports. Recent increase forward selling of the CNY at a similar magnitude to late 2015 does not shed enough light on the subject, either.

But historically the CNY has been closely correlated with the change in forex accumulation. As forex accumulation declines, the CNY weakens to the level last seen at the depth of the trade war in late 2018 (Figure 1).

We can also use the “Shadow CNY Exchange Rate” as a proxy for the divergence between the Fed and the PBoC. We define the “Shadow CNY Exchange Rate” as the ratio between China’s M2 and FX reserve. Recently, Chinese M2 growth continues to accelerate to its fastest in over seven years, likely a result of fiscal expenditure starting to pour into the economy. It is not surprising to see the shadow CNY exchange rate weakening to its worst in data history, while the USD strengthens (Figure 2). The USD strength will likely persist, as the PBoC and the Fed split further apart.

Figure 2: Shadow CNY (M2/FX reserve) at all-time high; USD is likely to strengthen further

Source: Bloomberg, GROW Research

CNY long-term trend weakening

Interestingly, the significant events in the history of CNY track very closely with the intersections between the CNY spot rate and its long-term trend line, as measured by the CNY’s 3.5-year moving average (Figure 3).

From early 1990s till before the “7.21 Currency Reform” in July 2005, the CNY spot rate stayed above its long-term trend line, showing a tendency of secular depreciation. The “7.21 Currency Reform” repeg the CNY to a basket of currencies, with a revaluation of the CNY. From then till the “8.11 Currency Reform” in 2015, the CNY spot rate stayed below its long-term trend line, exhibiting a tendency of secular appreciation.

Since then, the CNY has weakened and often stayed above its long-term trend line, affected by the trade war in 2018 and the pandemic in 2020. The “8.11 Currency Reform” in 2015 was to introduce two-way vacillations in the CNY exchange rate, and thus the CNY spot rate had been oscillating around its long-term trend line. As exchange rate movements tend to be protracted and serially correlated, the CNY will likely weaken further from 7 – corresponding to the epic strength in the USD as discussed above.

Figure 3: CNY’s key historic events track closely along its 3.5-year cycle

Source: Bloomberg, GROW Research

What does a weakening CNY mean for risk assets

As the currency of a country that tends to lead global economic cycle and is still largely cyclical in nature, the CNY has been a perceptive indicator of economic and market risks. For instance, the CNY spot rate is very closely correlated with the Gold/Copper ratio, a traditional risk indicator. In general, the weaker the CNY, the higher the Gold/Copper ratio, the higher the systemic risk and the lower the risk appetite (Figure 4).

Figure 4: CNY weakness hints at rapid deterioration of fundamentals & risk aversion

Source: Bloomberg, GROW Research

In the 2018 economic cycle and during COVID, the CNY actually led the Gold/Copper ratio in identifying risks. As aforementioned, the CNY weakness is unlikely to have concluded, as global economic data continue to deteriorate. As such, a weakening CNY hints at looming market risks ahead. While the CNY weakness is stretched in the near term, and thus could see some technical bounces, we would not recommend catching falling knives. The final plunge in global markets is impending. And the final curtain tends to fall with an abrupt blow.

August retail growth was a pleasant surprise, helped by the tax rebate for car purchases. In the past two weeks, high-frequency data suggest that car sales have started to decelerate. The spur from tax rebate seems to be tapering. Meanwhile, Chinese households are rushing to pay off mortgages, and long-term household loan growth (mostly mortgage) shown in August financial stats has yet to recover. The intention to buy a property is very low, while the intention to save soars.

Anecdotes suggest that banks are finding it easy to surpass this year’s target of deposit growth. But not so much for loan growth. Gone are the days when bank branch managers went on binge drinking with potential clients to attract deposits in order to fulfill their deposit quotas. Of course, ample deposits leave leeway for banks to lend when the economic cycle eventually turns.

If money is sleeping in deposit accounts, then risk assets such as stocks will not have to vigor to rise. Historically, the Shanghai Composite and bank deposits are inversely correlated (Figure 5). Our market risk indicator EYBY has fallen to a very low level, but not yet at its extreme, especially considering the challenges that we are facing are arguably the biggest since 2009 (Figure 6).

Figure 5: Rising deposits bode ill for stocks

Source: Bloomberg, GROW Research

Figure 6: Market is risk-averse, but not yet at its historical extremes

Source: Bloomberg, GROW Research


The epic CNY weakness is telling. It reflects the divergence between the Fed and the PBoC, and the decline in FX accumulation despite the stunning strength in Chinese exports. The CNY is exhibiting secular weakness, and as such has the tendency to stay above its long-term trend measured by its 3.5-year moving average. It would not be surprising to see the CNY depreciate further beyond 7. It is just economic cycle at work – as always.

A weakening CNY bodes ill for looming market risks. As such, money is dormant in depositaccounts, and our proprietary market risk indicator is not yet at its lowest extreme toreflect fully the perils ahead.

Please click here to download the full report in PDF:

English Report: 《Hao Hong: “Chill” about CNY Beyond 7》

中文版报告:《洪灝:佛系“破 7”》


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