What We Are Watching During Periods Of Volatility: The Chinese Renminbi

by: Invesco US

Summary

The recent depreciation of China’s currency, the renminbi (RMB), has increased the volatility of currency pairs across Asia and may affect markets across the world.

The Chinese authorities are using various tools in an attempt to control the pace of depreciation of their currency.

At Invesco Fixed Income, we watch the level of the Chinese currency very closely, both onshore and offshore. In addition, we closely monitor other indicators for signs of potential stress.

Understanding Developments In The RMB Market Is Critical To Understanding Global Markets

By Rob Waldner and the Invesco Fixed Income Macro Research team

Volatility in China has been a major driver of global markets, and Chinese foreign exchange policy has been a critical aspect of this volatility. The recent depreciation of China's currency, the renminbi (NYSEARCA:RMB), has increased the volatility of currency pairs across Asia and may affect markets across the world.

Since August, the Chinese have devalued their currency by nearly 7%.1 The depreciation of the RMB has picked up pace since its addition to the International Monetary Fund's Special Drawing Rights (SDR) basket of reserve currencies on Nov. 30, depreciating by over 3%.1

In addition, the difference between the onshore-traded (CNY) and offshore-traded (NYSE:CNH) RMB has been very volatile since the addition to the SDR basket. The difference between these two versions of the RMB reached a record wide level just after the New Year.2

Under control?

The Chinese authorities are using various tools in an attempt to control the pace of depreciation of their currency. Their primary tool is currency intervention. When intervening, the Chinese central bank purchases CNH or CNY in the open market. They have also intervened verbally, seeking to control market expectations by suggesting that the currency will remain stable.

Chinese currency, global effects

Volatility in Chinese currency has many global implications. Currency movements and currency policy significantly impact Chinese growth, global growth and global financial stability. Rapid, volatile depreciation of the RMB may be an indicator of increasing stresses with the Chinese economy. Chinese investors have built a large stock of capital onshore in China. As this capital flees China in search of better investment opportunities, it puts downward pressure on the currency and forces the central bank to intervene. The large size of these capital flows and the associated intervention can have a substantial impact on global financial markets.

Chinese currency depreciation also tends to cause depreciation among the entire Asian currency bloc, for example, the Korean won and Taiwanese dollar. In turn, Asian currency depreciation reduces the cost of imports in the US and could make it more difficult for the Federal Reserve to continue raising interest rates. Developed market policy makers are generally seeking to raise their rates of inflation, and importing Chinese deflation will likely make their task more difficult.

What we are watching

At Invesco Fixed Income, we watch the level of the Chinese currency very closely, both onshore and offshore. In addition, we closely monitor other indicators for signs of potential stress. For example, we monitor the spread between the CNH and CNY for an indication of how much control the Chinese authorities have over their currency. Authorities have preferred a tighter spread, therefore, a sharp widening may indicate a potential loss of control and could adversely affect markets. Additionally, we closely watch levels of RMB traded in forward markets as an indicator of potential speculation against the CNH. Speculators typically trade forward rates, and this type of transaction can add significantly to devaluation pressure.

Keeping a close eye on these levels and spreads allows us to understand and anticipate the effects of Chinese currency movements on other global market prices - on days when there is a large Chinese depreciation, risky assets have underperformed and global inflation expectations decreased. Going forward, we believe understanding developments in the RMB market will likely continue to be critical to understanding global markets.

Sources

  1. Bloomberg L.P., Jan. 8, 2016.
  2. Bloomberg L.P., Jan. 6, 2016.

Important information

Spread represents the difference between two values.

The Special Drawing Rights basket is an international reserve asset that was created by the International Monetary Fund in 1969 to supplement its member countries' official reserves.

Investments in companies located or operating in Greater China are subject to the following risks: nationalization, expropriation, or confiscation of property, difficulty in obtaining and/or enforcing judgments, alteration or discontinuation of economic reforms, military conflicts, and China's dependency on the economies of other Asian countries, many of which are developing countries.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE
Click to enlarge

All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is the US distributor for Invesco Ltd.'s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd.

©2016 Invesco Ltd. All rights reserved.

What we are watching during periods of volatility: The Chinese renminbi by Invesco Blog

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.