USD/CNH to continue upwards trend in 2017 – Danske Bank

Research Team at Danske Bank notes that since the spring of this year, USD/CNH has been on a strong upward trend and the recent increase in their view mainly reflects the combination of a strong uptick in the USD, which the People’s Bank of China (PBoC) has largely allowed to pass through to USD/CNH.

Key Quotes

“It further reflects that the PBoC is targeting USD/CNH to a lesser extent, instead focusing on keeping CNH stable against a basket of currencies, which it has succeeded in doing over the past five months.”

“An important driver of the recent rise in USD/CNH is relative monetary policy, as illustrated by the growing divergence between the USD and CNH monetary base. The PBoC’s lower emphasis on a stable USD/CNH has allowed for this divergence. We look for it to grow in 2017, when we expect the Federal Reserve to speed up the hiking cycle, which, together with full implementation of Basel III, we believe is likely to force the USD monetary base lower.”

“We also expect the USD to be in demand in 2017, supported by expectations of a ‘Homeland Investment Act 2’, concern about protectionist trade policies (e.g. import tariffs) and reforms that increase US growth potential among other things. In contrast, we expect demand for CNH in 2017 to come under pressure from structural economic headwinds, high and rising debt and gradual capital outflows from net foreign direct investments and portfolio investments. On currency vulnerability, both the USD and CNY score negatively. We forecast USD/CNH at 7.30 in 12M.”

“The biggest risk to the success of this trade is probably that there are still many unknowns about the policies of US President-Elect Donald Trump. While on balance we view policies as being USD positive at present, this could quickly change, e.g. if fiscal expansion outweighs the positive factors mentioned above, causing the USD to plunge. Another concern could be if the EUR rallies on the back of positive outcomes to the long list of political events over the coming year (Wild card). This might prompt PBoC to appreciate CNH vis-à-vis the USD to keep CNH stable against the basket.”