Following the Spring Festival, the Renminbi (RMB) exchange rate has experienced a rapid appreciation. While the USD/CNY rate fell below 7 near the end of last year, it has recently rebounded past 6.9, reaching near 6.88.
This round of RMB appreciation was largely anticipated. In the "Top Ten Predictions" released over the past two years, it was frequently suggested that the US dollar index would gradually decline, and the RMB exchange rate was expected to see sustained appreciation. Previously, the USD/CNY rate had depreciated to 7.4, leading to pessimistic market sentiment, with some even fearing the rate could breach 8. However, against the backdrop of persistent US dollar oversupply and the Federal Reserve entering an interest rate cutting cycle, the US dollar index is projected to decline gradually, thereby driving the appreciation of non-US currencies, including the Renminbi.
Over the past year, the Federal Reserve has implemented multiple interest rate cuts, and further cuts are still anticipated in the latter half of this year. In this context, the US dollar index has seen a noticeable decline, providing support for the Renminbi's appreciation.
Several factors are driving the Renminbi's strength. First is the impact of the retreat in the US dollar index. Second is a significant increase in corporate demand for foreign exchange settlement. During the period of Renminbi depreciation in recent years, some export-oriented enterprises delayed settling their foreign exchange earnings, holding onto more US dollar assets instead. At that time, the USD/CNY rate was around 7.1 to 7.2. As the Renminbi continues to appreciate, these companies are now accelerating their foreign exchange settlement. Statistics indicate that the scale of foreign exchange settlement over the past two years may have exceeded one trillion US dollars, making this another significant factor propelling the Renminbi's rise.
From a fundamental economic perspective, a series of important policies supporting economic recovery were introduced on September 24, 2024, including measures to stimulate consumption and expand investment. This year's government work report further proposed issuing approximately 250 billion yuan in special government bonds to promote a consumer goods "replacement" program, aiming to boost consumption growth and push price levels higher through increased subsidies.
This year's GDP growth target is set between 4.5% and 5%, with a CPI target around 2%. The anticipated recovery of price levels from near-zero growth will help bolster market confidence in the economic recovery. This, in turn, is expected to strengthen the willingness of various funds to allocate to Renminbi-denominated assets, providing underlying support for the exchange rate.
Therefore, the current Renminbi appreciation results from a combination of factors and also reflects global capital's positive outlook on Renminbi assets. As foreign capital flows into the A-share and Hong Kong stock markets, requiring conversion into Renminbi or Hong Kong dollars, this also supports demand for the Chinese currency.
Currently, the trend of Renminbi appreciation persists, and the exchange rate is expected to maintain relative strength in the short term.
However, to prevent excessively rapid appreciation from harming the competitiveness of export enterprises, the State Administration of Foreign Exchange recently reduced the foreign exchange risk reserve ratio from 20% to 0%. This measure aims to stabilize the exchange rate, keeping it fluctuating near a reasonable and balanced equilibrium level rather than appreciating too quickly. The policy has had a noticeable effect, moderating the pace of the Renminbi's rise and leading to some recent volatility in the exchange rate.
Should the pace of appreciation accelerate again later, the central bank may employ other measures to stabilize the exchange rate, including operations in the foreign exchange market, to prevent rapid appreciation from negatively impacting exporters.
Maintaining exchange rate stability is a key policy objective, crucial for ensuring the stability of China's import and export trade. Excessive exchange rate volatility, whether rapid appreciation or depreciation, can pose significant exchange rate risks for foreign trade enterprises.
Some processing trade enterprises operate on thin profit margins. Significant exchange rate fluctuations could erode their profits through exchange losses. The time lag between receiving foreign exchange income and settling it means that greater volatility increases the difficulty of foreign exchange management for companies. Consequently, the central bank will utilize various tools to maintain two-way fluctuation of the Renminbi at a reasonable and balanced level, avoiding one-sided rapid moves.
Numerous factors influence the Renminbi exchange rate, including the pace of Federal Reserve rate cuts, developments in the Middle East situation, and the timing of corporate foreign exchange settlements.
Entering the second quarter, close attention must be paid to developments in the Middle East. Recent attacks by the US and Israel on Iran, followed by Iranian retaliation and the announcement of a blockade on the Strait of Hormuz, are critical. The Strait of Hormuz is a vital global oil transit chokepoint, accounting for approximately 20% of global oil shipments. A prolonged blockade could lead to further increases in international oil prices.
International oil prices have already surpassed $110 per barrel. An extended conflict could push prices even higher. Rising oil prices would fuel global inflation, particularly impacting US price levels significantly.
In such a scenario, the Federal Reserve's timeline for interest rate cuts could be affected. Previously, markets anticipated that new Chair Wash might commence a rate-cutting cycle in June following the end of Chair Powell's term. However, if rising oil prices reignite inflationary pressures, the Fed might delay its easing plans.
Recently, the US dollar index has rebounded somewhat, approaching 99. Whether it breaks above 100 will depend on developments in the Middle East. An escalation of the conflict could significantly impact the dollar index and, consequently, the Renminbi's trajectory.
Conversely, if the Middle East conflict de-escalates relatively quickly, market expectations could shift again, potentially bringing forward the timing of Fed rate cuts. This would likely lead to a decline in the dollar index, once again supporting Renminbi appreciation.
Therefore, the second quarter requires close monitoring of the Middle East situation, as it will significantly impact global currency markets through its effects on oil prices and Federal Reserve policy.
During periods of Renminbi appreciation, increased inflows of foreign capital into Renminbi assets are typically observed. This should provide some support for the ongoing steady bull market in A-shares.
Renminbi appreciation can also enhance the value of certain listed companies. Sectors such as banking, airlines, and some resource companies may benefit. Airlines typically carry significant US dollar-denominated debt; Renminbi appreciation reduces their debt servicing burden, making it positive for the aviation industry.
Similarly, resource sectors like non-ferrous metals, coal, and chemicals may also benefit. The recent rise in international oil prices is particularly favorable for listed companies in the oil and gas sector, which may see stronger stock performance.
However, Renminbi appreciation could adversely affect investors holding US dollar assets. Some individuals previously converted assets into US dollars to benefit from higher deposit rates. If the US dollar depreciates, they could face exchange rate losses. Therefore, when considering currency conversion, one must weigh not only interest rate differentials but also exchange rate volatility risks.
From an asset allocation perspective, the A-share market is currently in a steady, long-term bull market. Retail investors may consider appropriately increasing their allocation to high-quality stocks or funds to participate in the long-term development of the capital markets.
This year, approximately 50 trillion yuan in time deposits are maturing. Meanwhile, time deposit interest rates have fallen from around 3% in the past to just over 1% currently. With the attractiveness of deposits diminished, some of these funds may flow into the capital markets.
Against the backdrop of persistent US dollar oversupply and global "de-dollarization" trends, the long-term upward trend for gold and silver remains intact. Gold and silver have been viewed favorably for the past two years. Although international gold prices have surpassed $5,000 per ounce, they still hold long-term allocation value as a hedge against US dollar depreciation.
It is therefore suggested that investors allocate approximately 20% of their portfolios to gold-related assets to strive for capital preservation and appreciation.
Overall, the government work report has reiterated the commitment to maintaining the basic stability of the Renminbi exchange rate at a reasonable and balanced level. Exchange rate stability aids import and export enterprises in managing their foreign exchange exposure and avoiding significant exchange losses.
At a previous annual meeting of the China Chief Economists Forum, it was projected that the Renminbi exchange rate would maintain an appreciating trend in 2026, with a trading range roughly between 6.6 and 7.0. Within this, 6.6 might represent a temporary upper limit, with the central parity rate hovering around 6.8.
The current exchange rate is already near 6.8, and it may continue to fluctuate within this range in the coming period, helping enterprises form stable expectations and manage their foreign exchange effectively.
Companies can utilize financial instruments like forward foreign exchange contracts to hedge exchange rate risk, locking in rates in advance to prevent volatility from eroding profits.
In summary, in an environment of increased exchange rate volatility, both enterprises and financial institutions should prioritize risk hedging over making one-sided bets on exchange rate movements. Proper foreign exchange management and asset allocation can effectively mitigate the risks associated with exchange rate fluctuations.
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