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From July 24 to 25, 2024, the USD/RMB exchange rate appreciated rapidly for two consecutive days, with the onshore and offshore exchange rates appreciating by 389 points and 491 points respectively, closing at 7.2360 and 7.2403 respectively on the 25th. As of August 1, the strongest intraday exchange rate of the above exchange rates reached around 7.21.Prior to this, the USD/RMB exchange rate had been rising at a low slope for more than half a year, and expectations for RMB depreciation were strong. This "sharp rise" of the RMB triggered discussions in the market about the turning point of the RMB.This report analyzes the macroeconomic basis and triggering factors of the sharp rise of the RMB, and on this basis puts forward our judgment on the future direction of the RMB exchange rate.

The "sharp rise" of the RMB from July 24 to 25 was mainly achieved against the backdrop of the decline in the US dollar index, the intensification of China's stable growth policies, and the record high trade surplus.

1. The US dollar index fell back

The US dollar index has fallen since July, but the RMB exchange rate has insufficiently reflected this, accumulating potential for "catch-up growth".The US dollar index rose above 106 on June 26, but then due to the weakening of key US economic data, including the non-farm data released on July 5 and the unexpected cooling of CPI data released on July 11, the market's expectations for the Fed's interest rate cut increased significantly, driving the US dollar index to fall all the way. From June 27 to July 24, the US dollar index fell by 1.6%, and fell to 103.7 on July 17, hitting a new low in nearly four months. During the same period, the RMB exchange rate did not rise, and remained in a narrow range around 7.27.

Compared with the appreciation of major Asian currencies, the RMB shows more "catch-up" characteristics.From June 27 to July 24, while the U.S. dollar index fell, Asian currencies, led by the Japanese yen, all saw a significant appreciation.During this period, the Japanese yen, Thai baht, Indonesian rupiah and other currencies appreciated by 4.3%, 1.8% and 1.3% against the US dollar respectively, while the RMB exchange rate depreciated slightly by 0.1%, deviating from the trend of major Asian currencies.After the RMB appreciated on July 25, its appreciation was still less than that of most Asian currencies.

2. Policies to stabilize growth have been strengthened

On July 18, the Third Plenary Session of the 20th CPC Central Committee adopted the "Decision of the CPC Central Committee on Further Comprehensively Deepening Reforms and Promoting Chinese-style Modernization", which solidified the determination to promote reforms in the next five years. At the same time, it also made high-level arrangements for current economic work, emphasizing "unswervingly achieving the annual economic and social development goals", "implementing macroeconomic policies, actively expanding domestic demand, and developing new quality productivity according to local conditions".After the conference, domestic policies to stabilize growth have been significantly stepped up and accelerated:On July 22, the central bank announced a 10bp interest rate cut.On July 25, the MLF cut interest rates by 20bp for the second time.Major state-owned banks collectively lowered their deposit interest rates.On the same day, the National Development and Reform Commission and the Ministry of Finance issuedSeveral measures to strengthen support for large-scale equipment upgrades and trade-in of consumer goods.It is clearly stated that the National Development and Reform Commission will take the lead in arranging about 300 billion yuan of ultra-long-term special government bond funds to increase support for large-scale equipment upgrades and old consumer goods replacements.

The long-awaited comprehensive interest rate cuts and concentrated fiscal stimulus have sent a signal that the policy focus is shifting toward "stabilizing growth", which is crucial to enhancing the international market's confidence in the Chinese economy and strengthening the foundation for the stability of the RMB.Although the interest rate cut is not conducive to narrowing the interest rate gap between China and the United States, from the perspective of market performance, the RMB exchange rate has shown a tendency to "exhaust all the negative factors" after the interest rate cut.” pointed out in the “New Economic Outlook on the Development and Reform of China’s Renminbi Exchange Rate” that due to the continuation of low domestic prices, a large gap has appeared in my country’s nominal and real effective exchange rate indices, and monetary policy has formed a combination of “high real interest rates domestically vs. low real exchange rates externally”. In other words, between interest rates and exchange rates, monetary policy is actually more inclined to stabilizing the exchange rate, and it is urgent to play a greater role in stabilizing growth domestically, so as to achieve the fundamental strengthening of the RMB exchange rate.

3. Trade surplus hits a new high

Exports became a highlight of China's economy in the first half of the year.In the first half of the year, the contribution of net exports of goods and services to my country's real GDP rose from -0.6 percentage points in 2023 to 0.7 percentage points, playing an important role in achieving a 5% GDP growth rate in the first half of the year. In particular, China's trade surplus reached US$99 billion in June, setting a record high for a single month. The surplus in goods trade is the main source of surplus in my country's international balance of payments. Maintaining a high surplus in foreign trade provides a solid foundation for the RMB exchange rate.

Short-term export resilience is expected to continue.We believe that China's exports in the third quarter have three supports:First, the external demand foundation for export growth is relatively good.The current "re-industrialization" of developed countries and the "industrialization" process of developing countries overlap and resonate.Since 2024, the US manufacturing industry has entered the upward phase of a new inventory cycle.Judging from the relatively stable inventory cycle length in the United States (3-4 years), this round of manufacturing inventory replenishment is expected to continue for 1-2 years, boosting the global manufacturing boom.At the same time, the manufacturing PMI in emerging and developing regions such as Brazil and India has further increased, and the "Brazil New Industry" plan and "Make in India" have injected new impetus into the global manufacturing boom.Second, the export “price” has rebounded.Breaking down the factors of quantity, price and exchange rate, the rapid growth of my country's exports in the first half of this year was mainly driven by quantity factors, while the decline in export prices and the depreciation of the RMB against the US dollar both dragged down the growth rate of export value denominated in US dollars.The rebound in the growth rate of international bulk commodity prices since the beginning of this year has not yet been fully reflected in my country's export prices. It is expected that its gradual impact on export prices will continue at least until November this year.Third, there is the possibility of “export rush” before the US election.The US election in November has brought uncertainty to the global economic and trade environment. Considering that policies such as tariffs on China may change after the change of US president, companies may demand to export in advance.

1. The appreciation of the Japanese yen creates a linkage

The Japanese yen has appreciated rapidly recently.Since July 10, the USD/JPY exchange rate has fallen from the 160 mark, and fell below the important psychological mark of 155 on July 24, and fell below 150 on July 31. There are a series of factors behind the appreciation of the yen: first, the Japanese government is suspected of multiple rounds of foreign exchange market intervention on July 11-12; second, there are many voices in Japan supporting the Bank of Japan to raise interest rates. Reuters reported on July 24 that the Bank of Japan will consider raising interest rates next week and plans to halve the scale of bond purchases in the next few years. The Bank of Japan "fulfilled" the interest rate hike on July 31, further boosting the appreciation of the yen; third, the strong expectation of the election of US presidential candidate Trump and his remarks in favor of a "weak dollar" also contributed to the expectation of yen appreciation.

The RMB and the Japanese Yen remain highly correlated.Since 2023, the 100-day rolling correlation coefficient between the RMB and the Japanese yen has averaged more than 0.8, while in 2021-2022 this correlation coefficient averaged only 0.25.The recent strong appreciation of the Japanese yen has exerted an emotional pull on the RMB.

The reason why the RMB and Japanese yen exchange rates have maintained such a high correlation since 2023 is mainly because both have the attributes of low-interest currencies in carry transactions.With the Fed's aggressive rate hikes since 2022, the interest rate gap between Japan, which maintains a super-loose monetary policy, and the United States has deepened, and China, which is out of sync with the US economic cycle, has also formed an inverted interest rate gap. The US-Japan interest rate gap and the US-China interest rate gap have both risen to historical highs. This has made the two major Asian currencies become financing currencies in carry trades, facing pressure to depreciate relative to the US dollar. And as the Fed's rate cut is confirmed and approaching, the reversal of this carry trade will undoubtedly form emotional contagion between the two currencies.

Adjustments in U.S. technology stocks further catalyzed the unwinding of yen carry trades.On July 24, the Nasdaq index fell 3.6%, and has fallen 7% since July 11.Over the past two years, U.S. technology stocks have maintained a strong upward trend, attracting global investors and becoming one of the important assets for yen carry trading.As predicted by Sakakibara, a former Japanese finance minister known as "Mr. Yen" on July 22, the U.S. stock market is entering a period of adjustment, the previously increased carry trade may begin to reverse, and the yen is expected to rise.The current short positions in the Japanese yen are very crowded. As of early July this year, the number of non-commercial net short positions in the Japanese yen on CME has reached its highest level since 2007. There is a large room for short position closing and a strong push for the Japanese yen.It is no coincidence that the rise in the Nasdaq Volatility Index was accompanied by a clear release of speculative net short positions in the Japanese yen. 

Although the interest rate gap between the United States and China is not as wide as that between the United States and Japan, the low volatility of the RMB exchange rate this year makes the RMB's attributes as a carry currency no weaker than the Japanese yen, and thus the trend logic of the two is similar.This is because, in the carry transaction between RMB assets and US dollar assets, if the RMB exchange rate against the US dollar appreciates significantly, exchange losses will occur, eroding the profits brought by the US-China interest rate differential.The low volatility and creeping depreciation of the RMB exchange rate since the beginning of this year have greatly reduced the exchange rate risk of carry trades, resulting in a large number of short positions in the RMB that are borrowed in RMB and exchanged for US dollars.However, after the market reverses, the carry trade will be reversed, and short selling will easily occur, accelerating the appreciation of the RMB.

2. Policy control signals

The policy regulation signals are mainly reflected in the tightening of offshore market liquidity and the relatively low USD/RMB swap point.

First, offshore RMB liquidity has been abundant, and the price has risen.Since the beginning of this year, the scale of RMB deposits in Hong Kong has hit a new high, exceeding 1 trillion yuan in April. This is partly related to the achievements made in the internationalization of the RMB. In recent years, the proportion of RMB in foreign-related receipts and payments made by Chinese banks on behalf of customers has increased significantly. Since June 2023, the scale of RMB in foreign-related expenditures has generally surpassed foreign currencies, allowing offshore RMB liquidity to grow. On the other hand, the scale of net purchases of Hong Kong-Shanghai Stock Connect funds has accelerated this year, and the southbound funds of the Guangdong-Hong Kong-Macao Cross-Border Wealth Management Connect have inflows rapidly, further enriching offshore RMB liquidity.

However, since July, it has been observed that the offshore RMB interest rate level has risen significantly, which may reflect the policy intention to increase the cost of shorting the RMB.Since July, the CNH Hibor overnight rate has risen rapidly from an average of less than 2% in June to a high of 5.76% on July 24. As of July 26, the monthly average reached 3.7%.The rise in offshore RMB interest rates means that the carry cost of borrowing RMB and exchanging it for US dollars has increased, which is a common way for policies to curb the irrational depreciation of the offshore RMB.When the USD/RMB exchange rate reaches a critical point, especially when the offshore RMB depreciates more than the onshore RMB, we tend to see a significant increase in the offshore RMB overnight interest rate, which in turn curbs the RMB's depreciation momentum. 

Second, the continuous decline in the RMB swap point also reflects to a certain extent the policy intention to stabilize the exchange rate.The central bank’s influence on foreign exchange swap points is also an effective means to correct unilateral market behavior.The pricing principle of foreign exchange swap points is mainly based on the interest rate parity theory.Foreign exchange swaps include two steps: spot exchange and forward settlement. The swap point is the difference between the spot exchange and forward settlement prices.According to the interest rate parity theory, the interest rate obtained from direct investment in the domestic country should be equal to the interest rate obtained from converting the investment into foreign currency and then settling it back after maturity. Otherwise, cross-border arbitrage will make the two converge.Therefore, the following equation holds:

Among them, R_f is the foreign interest rate level, R is the domestic interest rate level, S_t is the spot exchange rate, and F_t is the forward exchange rate. By shifting the terms, we can get the theoretical formula of the foreign exchange swap point:

It can be seen that when the domestic interest rate is lower than the foreign interest rate, the swap point is at a discount, and the greater the interest rate gap, the greater the swap point discount.As the interest rate gap between China and the United States narrowed and inverted in 2022, the foreign exchange swap point of the USD/RMB also changed from premium to discount, and then fluctuated downward, which was determined by the interest rate parity theory.

However, since the fourth quarter of 2023, the decline in swap points has begun to exceed the theoretical value more significantly. An intuitive manifestation is that the US dollar interest rate implied by the foreign exchange swap point significantly exceeds the actual US dollar financing rate.In other words, the cost of enterprises directly obtaining US dollar financing overseas is lower than the comprehensive cost of financing in RMB, converting it into US dollars, converting it back to RMB after maturity, and repaying the RMB loan through foreign exchange swaps. This is to discourage domestic cross-border interest arbitrage. On the contrary, for foreign capital, it means that the yield on holding US bonds is lower than the yield on holding Chinese bonds through foreign exchange swaps.

This is why, with the interest rate gap between China and the United States at an extremely low level, the scale of Chinese bonds held by overseas institutions has shown a significant rebound since the fourth quarter of 2023.Taking the data on July 1, 2024 as an example, the USDCNY spot exchange rate is 7.2684, and the 1-year swap point is -2952BP. The corresponding exchange rate income of holding RMB is 4.06%, and the 1-year treasury bond yield during the same period is 1.56%.Adding up investment income and exchange gains, the total yield of overseas institutions investing in Chinese government bonds through foreign exchange swaps is approximately 5.62%, higher than the 5.1% yield on one-year US Treasury bonds.This situation will help capital inflows under the financial account, which in turn will help ease the pressure on RMB depreciation and guide expectations.

1. Limited room for “catch-up”

In the short term, the room for the RMB to "catch up" is relatively limited.After the RMB appreciation on July 25, the USD/RMB has only risen by 1.8% this year, which is less than the 3.0% of the US dollar index, and is also less than a series of Asian currencies such as the US dollar against the Japanese yen (9.1%), the New Taiwan dollar (6.6%), the Thai baht (5.7%) and the Indonesian rupiah (5.4%). Even if we consider the day before the RMB appreciation, that is, the appreciation of the USD/RMB by 2.6% as of July 24 this year, it is still less than the 2.9% increase of the US dollar index and the depreciation of the above-mentioned major currencies. It can be seen that the RMB exchange rate has remained relatively strong this year. In other words,The RMB exchange rate has not risen for nearly a month, which is also due to the fact that it has not fallen before.This means that the room for the RMB to "catch up" this time may not be wide. As we pointed out in the report "New Characteristics and Trends of the RMB Exchange Rate", the strength of the RMB exchange rate this year is partly due to the constraints of the stable central parity rate. On July 26, the US dollar rebounded to 7.25 against the RMB, and the year-to-date increase slightly expanded to 2.3%.

Since the "811" exchange rate reform in 2015 (which greatly increased the correlation between the USD/RMB exchange rate and the US dollar index), judging from the correlation between the USD/RMB exchange rate and the US dollar index, the USD/RMB exchange rate level after this appreciation is basically within a reasonable range.

2. The US dollar will not weaken easily

Looking ahead to the coming period, we tend to believe that the US dollar index will not weaken anytime soon.The current outlook for the U.S. dollar is rather uncertain, with three specific uncertainties:

First, the prospect of the Fed's interest rate cut has changed from "very certain" to "less certain."Since the U.S. CPI data cooled on July 11, the CME interest rate futures market has basically confirmed that the Fed will cut interest rates in September, at least twice this year, while the Fed's median forecast in June was only one rate cut this year. Data released on July 25 showed that the U.S. GDP in the second quarter was significantly higher than expected, and the second quarter core PCE price growth rate was slightly higher than expected. As the U.S. economy slowly "landed", economic data and expectations of interest rate cuts are prone to twists and turns, and cautious interest rate cuts may not necessarily drive a significant weakening of the U.S. dollar.

Second, the outlook for the Japanese yen and European currencies seems to be reversing and diverging.The Bank of Japan raised interest rates at the end of July and announced a plan to reduce its balance sheet. The yen is likely to continue to appreciate.But the European economy has not been doing well recently.The eurozone manufacturing and services PMIs released on July 24 both fell short of expectations.After the data was released, the Citigroup Economic Surprise Index for Europe turned negative and hit a new low since February this year, which also further reduced the difference between the Citigroup Surprise Index in Europe and the United States.Currently, the euro-dollar exchange rate is still at a relatively high level this year, and there may be pressure for depreciation.If the euro and the yen move in opposite directions, it will be difficult for the U.S. dollar index to fall quickly.

Third, the US election and its impact on the US dollar exchange rate have become more complex.Since July, under the overseas "Trump deal" market, the trend of the US dollar index lacks direction. The main reason is that Trump's vision of a "weak dollar" is in conflict with the expectation of a "strong economy". On several key "Trump deal" dates on June 28 (Trump dominated the debate), July 15 (Trump was assassinated), and July 22 (Biden withdrew from the election), the 10-year US Treasury bond interest rate rose to varying degrees, reflecting the market's expectations for medium-term US fiscal expansion and economic (inflation) growth. Moreover, since late July, Biden's withdrawal from the election and Harris' strong participation have made this election more complicated. The US election situation and its impact on the US dollar exchange rate remain to be seen.

3. The Sino-US economic and trade game contains risks

Since the Sino-US trade conflict broke out in 2018, we can often get a glimpse of the rhythm of the Sino-US trade game by comparing the relative cumulative increase in the USD/RMB exchange rate and the US dollar index: whenever the Sino-US trade conflict heats up, the USD/RMB exchange rate tends to appreciate more. In 2020, China and the United States reached a first-phase trade agreement. Since then, Biden was elected. The impact of the COVID-19 pandemic has highlighted China's industrial chain advantages, brought about a significant increase in China's export market share, and led to a round of appreciation of the RMB exchange rate. In 2022, with the release of the "2021 China Human Rights Report" by the United States, the Sino-US trade conflict has once again tended to heat up. As the new US election approaches, Sino-US trade frictions are becoming more frequent.It can be said that the current difference between the USD/RMB exchange rate and the US dollar index implies expectations for relatively stable Sino-US economic and trade relations.However, considering Trump's radical remarks on China's economic and trade policies and his high probability of winning the election, if frictions in the economic and trade field between China and the United States escalate again in the future, the renminbi will still be under pressure to depreciate.

4. Some repressive factors still need to be reversed

Judging from China's current international balance of payments situation, there are still several suppressive factors on the RMB exchange rate. Whether the RMB can continue to appreciate fundamentally depends on whether the Chinese economy can maintain steady and long-term development.

First, the interest rate gap between China and the United States is still at a historical low, and there are still great constraints on capital inflows under the financial account.As of July 26, the 1-year and 10-year U.S. bond yield spreads reached -3.3% and -2.0%, respectively. Recently, as the Fed's expectations for rate cuts have increased, the yield on short-term U.S. Treasury bonds has tended to decline; and the People's Bank of China has created a "quasi-interest rate corridor" to constrain the downward space of China's short-term Treasury yields, resulting in a slight rebound in the short-end of the U.S.-China interest rate spread. As the resilience of the U.S. economy has been frequently shown, the interest rate on long-term U.S. Treasury bonds has remained basically stable; the People's Bank of China has continuously laid the groundwork for "borrowing bonds and selling bonds", which has also hindered the downward trend of China's long-term Treasury bond interest rates, so the long end of the U.S.-China interest rate spread has only narrowed slightly.The key to breaking the deadlock in the interest rate gap between China and the United States still lies in the competition between the resilience of the Chinese and American economies. The focus will be on whether the Federal Reserve will continue to cut interest rates and whether China's stable growth can achieve more practical results.

Second, there are still double deficits in banks' foreign exchange settlement and sales on behalf of customers and foreign-related receipts and payments.In June, the difference of foreign exchange settlement and sales on behalf of customers by banks was -39.65 billion US dollars, and the difference of foreign-related receipts and payments on behalf of customers by banks was -23.496 billion US dollars, reflecting that the tendency of capital outflow is still relatively large.Except for the surplus in goods trade, the trade in services, income and current transfers, and capital and financial items were all in deficit. Compared with the historical situation,The main reason why the total balance of payments turned from positive to negative was that the capital and financial items turned into a deficit.

Among capital and financial projects, the contribution to the deficit mainly comes from direct investment.In the first five months of this year, foreign direct investment denominated in RMB fell by 27.9% year-on-year, while non-financial and all-industry foreign direct investment denominated in US dollars increased by 16.3% and 9.8% year-on-year respectively.To ease the net capital outflow under direct investment, foreign direct investment needs to stabilize and recover.The Third Plenary Session of the 20th CPC Central Committee has deployed measures such as "creating a first-class market-oriented, law-based and internationalized business environment, protecting the rights and interests of foreign investors in accordance with the law", "implementing the complete abolition of restrictions on foreign investment access in the manufacturing sector, and promoting orderly expansion of opening up in areas such as telecommunications, the Internet, education, culture, and medical care", and "ensuring national treatment for foreign-invested enterprises in terms of factor acquisition, qualification licensing, standard setting, and government procurement". These reform measures will help the performance of the RMB exchange rate.

Third, enterprises and residents still have a strong desire to hold foreign exchange.In June, the willingness to settle foreign exchange (= banks settling foreign exchange on behalf of customers/banks’ foreign currency income from foreign-related activities on behalf of customers) dropped to 58%, while the willingness to sell foreign exchange (= banks selling foreign exchange on behalf of customers/banks’ foreign currency payments to foreign countries on behalf of customers) rose to 71.8%. The gap between the two widened significantly, reflecting strong expectations for RMB depreciation and market players’ greater inclination to hold foreign exchange.In June, the surplus of foreign receipts and payments in goods trade was still significantly higher than the surplus of foreign exchange settlement and sales, which indirectly reflects that enterprises are less willing to convert the foreign exchange they earn into RMB, hoping to wait for better settlement prices.With the release of the RMB's volatility elasticity, it will be of great benefit in correcting expectations of RMB depreciation. The willingness of economic entities to convert foreign exchange into RMB will also be restored, thereby strengthening the momentum of RMB appreciation.

risk warning:1. The US economy and inflation have risen beyond expectations, and the Fed has postponed or increased the interval between subsequent rate cuts, driving the appreciation of the US dollar and exerting depreciation pressure on the RMB exchange rate;2. The intensification of trade protection policies by the United States and Europe may drive the overall depreciation of Asian currencies;3. The significant escalation of Sino-US economic and trade conflicts may trigger a greater depreciation of the RMB exchange rate;4. The implementation effect of China's stable growth policy has not been as good as expected, and China's economic slowdown has put pressure on the RMB exchange rate;5. The continued decline in foreign direct investment has increased the pressure of capital outflow, which has continued to put pressure on the RMB exchange rate;6、China's monetary policy has been significantly loosened, exacerbating the inverted interest rate differential between China and the United States and increasing the pressure on the depreciation of the RMB;7. The adjustment time and magnitude of the US stock market exceeded expectations, further driving the appreciation of the Japanese yen and triggering a linked appreciation of the RMB exchange rate.