China: Strong reasons for the PBOC to stay the course - ING

Tim Condon, Chief Economist at ING, assumes that the PBOC is likely to keep the NEER steady and ING’s forecast that USD/Majors will be range bound is behind their yearend 6.47 USDCNY forecast.

Key Quotes

“We credit more predictable PBOC USDCNY fixings since the second week of January and the tightening of exchange controls/macropru for the swing in monthly reserve changes from US$100 billion per month of outflows in November-January to a US$10.3 billion inflow in March. The first increase in five months put reserves at US$3.213 trillion.

We think there are strong economic and political reasons for the PBOC to stay the course when it comes to its fixing policy. There is some uncertainty about what that course is, however. Estimates of the CFETS NEER currency basket, including ours, show a steady depreciation since March, which has been a period of general USD/Majors (DXY) weakness.

When DXY depreciates the PBOC should fix USDCNY lower (appreciate CNY) to keep the NEER steady and vice versa. However, we think the PBOC reacts asymmetrically to changes in DXY: when DXY depreciates the PBOC depreciates the NEER by fixing USDCNY higher than would be consistent with an unchanged NEER. We think it keeps the NEER stable when DXY appreciates; it fixes USDCNY higher (depreciates CNY) to keep the NEER steady.

We also think this is more of a guideline than a rule. If were a rule it would have implied a CFETS NEER depreciation yesterday after DXY depreciated 0.21%. Instead, on our measure the NEER appreciated. We attribute the PBOC’s departure from the rule as a reaction to an unwanted widening in the CNH-CNY basis associated with the recent NEER depreciation. In the event, the basis narrowed on last Thursday.

For forecasting purposes we assume that the PBOC keeps the NEER steady. That and ING’s forecast that USD/Majors will be range bound is behind our yearend 6.47 USDCNY forecast (spot 6.47, Bloomberg median 6.71, forward 6.62).”