7 is just a number

clock • 2 min read

Over the past several months, there has been hype about the prospect of the Chinese renminbi (RMB) weakening past 7 per US dollar, despite no evidence that 7 is a magical number. China's central bank, the People's Bank of China (PBOC), had denied that it was focused on defending 7, and the IMF said it wasn't significant. So when the RMB finally broke 7, the media treated it as a dramatic event, but we believe, this will soon pass.

It is likely that the timing of the move was deliberate, following president Trump's latest round of tariffs.

We believe Xi Jinping is unlikely to resort to a significant devaluation (which was not what happened yesterday) to respond to Trump. The tariffs are having little direct impact on China's economy (net exports were less than 1% of China's GDP last year, and only 20% of total exports went to the US), and Xi has far better tools to deal with the more significant indirect impact: weak confidence by manufacturers, who have slowed output and deferred investment.

China's consumer story—the largest part of its economy—remains pretty healthy, as does employment and wage growth, so there is no reason for Xi to panic.

We believe the latest currency move was not driven by US dollar (USD) strength, but a short-term political signal by Xi: over the last week, the US Dollar Index (DXY) fell 0.4%, while the RMB also declined 0.6% against the USD. Over the longer term, however, the direction of the RMB versus the USD continues to be determined by the strength (or weakness) of the dollar. Since the start of the year, the DXY is up 1.6% and the RMB is down 0.9% vs the USD. Since the start of 2015, the DXY is up 8.2% and the RMB is down 11.6% vs the USD.

We expect this longer-term pattern to continue. Xi has many tools available to deal with slower export growth, which is why the [Chinese Communist] Party hasn't resorted to significant devaluation in the past, including during the Global and Asian Financial Crises.

 

Andy Rothman, investment strategist, Matthews Asia