Contributed by Jeff Cheah, Strategic Sales Manager
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The economic data disclosed since September show that the U.S. economy is highly resilient, and leading indicators have recovered. The economic and monetary policy differences between the United States and non-U.S. countries have intensified, causing the USD index to rise again. The RMB has weakened due to the strengthening of the USD. As the short-term USD index may continue to run at a high level above 100, the RMB is facing certain intermittent external pressures.
The U.S. economic resilience constitutes the core support of the USD. The ISM non-manufacturing PMI increased significantly in August (54.5 actual vs. 52.5 expected), and the ISM manufacturing PMI and Markit manufacturing PMI both exceeded expectations and previous values. At the same time, although the U.S. employment data for August disclosed on September 1 showed that the U.S. labor market has weakened, the three-month moving average of new non-agricultural employment is still at a healthy level, and the job vacancy rate in some industries, especially the service industry, has eased.
Considering that the U.S. economic growth continues to be above the potential growth rate, it is expected that the U.S. labor market will still be resilient. In addition, the recent speeches of two Fed officials reflect that they are very cautious about whether to stop raising interest rates in the future and do not want to repeat the mistake of "doing too little".
Recently, the European economic momentum has weakened, and the economies of the UK, Australia, and other countries have further diverged from the U.S. economy, which has promoted the strengthening of the U.S. dollar. The comprehensive PMI and service PMI of the Euro area have further declined. The latest data disclosed by major European countries also shows the sluggish economic situation in Europe. In addition, the government of Birmingham, the UK's second-largest city, declared bankruptcy on September 5 due to rising social care spending, reduced corporate taxation, and high inflation.
In addition, the UK’s PMI, service industry PMI, and manufacturing PMI all fell further in August. The PMI and service industry PMI have declined for the first time since 2021. Although Australia's GDP growth in the second quarter exceeded expectations, its consumption still showed a weakening trend. After inflation, wage growth, and employment were lower than expected, Australia decided to keep its policy interest rate unchanged on September 5. Market expectations for Australia to end interest rate increases have increased, and the monetary policy divergence between Australia and the United States has further intensified, causing the AUD to depreciate significantly against the USD.
For this week, the key risk event will be on Wednesday, when CPI prints will be released. This will determine the directional bias of the USD before the FOMC convenes. For now, we are comfortable riding on the US economic resilience narrative.
RMB Continues to Drag
Since the second quarter of this year, the RMB has been weak. In addition to the high USD index, it is also related to the loose domestic monetary policy and the slowdown in China's economic recovery slope in the second and third quarters. In June and August this year, MLF interest rates in the domestic market were reduced by 10bps and 15bps respectively, exceeding market expectations. The central bank's monetary policy remains loose overall.
The slope of China’s economic recovery has slowed down in the second and third quarters. The y/y growth rates of retail sales and exports slowed to 2.5% and -14.5% respectively in July. The growth rate of fixed asset investment also slowed to 1.2% in July. Compared with the cumulative growth rate from January to July this year, the July growth rate of the above three demand-side indicators fell by 4.8 percentage points, 2.2 percentage points, and 9.5 percentage points respectively, and the economic recovery slope further slowed down.
Due to the recent weak performance of the RMB, the PBoC announced on September 1[1] that it would lower the foreign exchange deposit reserve requirement by 2 percentage points. Starting from September 15, 2023, the central bank will lower the foreign exchange deposit reserve ratio of financial institutions by 2 percentage points, that is, the foreign exchange deposit reserve ratio will be lowered from the current 6% to 4%.
Looking back at history, the central bank has adjusted the foreign exchange deposit reserve ratio four times, including two increases in 2021 and two decreases in 2022. In April 2022, due to the rising global risk aversion sentiment under the Russia-Uzbekistan conflict and the rebound of the domestic epidemic situation, the fluctuation of the RMB exchange rate intensified. To alleviate the pressure of the weakening of the RMB, the central bank announced on April 25, 2022, that it would lower the foreign exchange deposit reserve ratio by 1 percentage point to 8%.
This move increased the dollar liquidity of domestic financial institutions to a certain extent, and once again signals the intent to stabilize the exchange rate. Lowering the reserve requirement ratio for foreign exchange deposits will increase the amount of dollars that commercial banks can use freely, and the increase in domestic dollars can relieve the pressure on the RMB to a certain extent. Lowering the foreign exchange deposit reserve ratio by 2 percentage points does not correspond to a large release of US dollar foreign exchange liquidity, so it is more expected to serve as a guide to stabilize the exchange rate.
Domestic policies have been gradually implemented after the Politburo meeting, but the effectiveness of the policies still needs time to take effect. As for the exchange rate, whether improvements in fundamentals can reverse the continued outflow of foreign capital in the capital market and direct investment may be the key factor in stabilizing the exchange rate.
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