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Recently, the RMB has appreciated significantly beyond expectations. As of 17:30 Beijing time on August 5, USD/RMB was at 7.1240 and USD/offshore RMB was at 7.1155. It had fallen below 7.3 not long ago.

On the 5th, the central parity rate of the US dollar against the RMB was 7.1345, which means that the central parity rate is no longer weaker than the spot exchange rate, which is rare in the past year. In addition, the offshore RMB price is inverted with the onshore price, and the depreciation expectations have begun to reverse. In the past year, in order to stabilize the exchange rate, the central bank has often used the US dollar RMB central parity rate to be nearly 1,000 points stronger than the spot price, sending a signal of stability. Traders now say that the day of "three prices in one" (onshore, offshore exchange rate and central parity rate) has finally come.

"The liquidation of yen carry trades has driven the yen to surge. The maximum increase in the yen against the U.S. dollar has been close to 14%, which has boosted the renminbi, which is also a low-interest currency. More importantly, the U.S. dollar index has broken through, and in the past two weeks some foreign trade traders have become impatient and started to convert their U.S. dollar income into renminbi, which may exacerbate this wave of increases." A foreign exchange trader at a foreign bank told the First Financial reporter.

"Three prices in one" under RMB appreciation

Barclays told reporters that the RMB was supported by the Bank of Japan's tough stance on raising interest rates and the Fed's clear signal of rate cuts to the market, and the market has fully digested the US interest rate cut expectations in September. The change in the central parity rate of the US dollar against the RMB shows that the People's Bank of China has more confidence to make the central parity rate weaker (the central parity rate was often set stronger than expected and modeled earlier to combat depreciation expectations), but the continued liquidation of carry trade positions and the start of foreign exchange settlement by Chinese exporters further promoted the RMB rebound.

Yicai.com has been reporting that the yen has been under pressure since the Fed started its rate hike cycle in March 2022, widening the real interest rate gap between the U.S. and Japanese markets. The interest rate differential has led investors to use the yen as a financing currency to go long on high-yield currencies such as the Mexican peso, Brazilian real, and more recently, the Turkish lira to realize carry. This financing strategy has performed well over the past two years, resulting in a significant increase in positions. However, as carry trades were unwound, currency pairs with higher volatility (currency peg) experienced a sharp reversal.

For example, in July, the Australian dollar fell by about 10% against the Japanese yen and the Mexican peso fell by about 10% against the Japanese yen. During this period, the volatility VIX (fear index) rose sharply from 12% to 20%, and the need to reduce volatility in portfolios also pushed the carry trade to reverse further. In contrast, the RMB fell less against the Japanese yen (6%) throughout July, while the RMB rebounded by 2% against the US dollar.

"The attractiveness of carry trades has plummeted, with EUR/JPY, GBP/JPY and AUD/JPY seeing sharp sell-offs in the past week," Jerry Chen, senior strategist at Forex, told reporters. "This process will continue to impact the market. As prices fall further, previous long positions will have a stronger motivation to liquidate, thereby locking in previously realized gains. Carry trades have shown more signs of coming to an end, and failure to act now could wipe out gains."

As of 15:32 Beijing time on August 5, the USD/JPY exchange rate was 142.02, down more than 12% from its previous historical high of 162.

At the same time, the impact of the Bank of Japan's "hawkish" stance cannot be underestimated.UBSMasamichi Adachi, chief Japan economist at the investment bank, told reporters, "The Bank of Japan raised its policy rate to 0.25% from 0.0%~0.1%, exceeding the expectations of most market participants, and the details of quantitative tightening have been finalized. We currently expect the Bank of Japan to raise its policy rate to 0.5% in October unless there is an unexpected deterioration in the Bank of Japan's quarterly survey."

UBS also expects the Bank of Japan to remain on hold in December and January next year to ensure high wage growth again in the spring negotiations for 2025, and then to raise the policy rate to 0.75% in March and 1.0% in June. "Compared with market pricing and other Bank of Japan watchers, our new policy rate hike forecasts are higher and faster (hawkish)."

The reason is that the agency believes that the Japanese economy will normalize (i.e. real GDP growth of 1%, CPI inflation of 2%, nominal wage growth and nominal GDP growth of 3%), achieving a "nominal growth revival". This view should be close to the Bank of Japan's main outlook and the government's "growth transformation". The change in corporate pricing behavior (i.e. rising inflation expectations) and wage growth exceeding expectations for two consecutive years have increased our confidence in the "nominal growth revival".

However, many institutions have previously believed that the Bank of Japan should not be so aggressive because people are always worried about the sluggish consumption. Despite the increase in disposable income, actual consumption continued to decline before the first quarter of this year. If the upward trend in the savings rate (or the downward trend in the propensity to consume) during the period from 2015 to 2019 is repeated, consumption growth will not be as fast as income growth.

Exporters' urgent foreign exchange settlement

In addition to the yen factor, the other two major reasons driving the appreciation of the RMB are undoubtedly the weakening of the US dollar and the subsequent foreign exchange settlement by Chinese exporters.

"Two weeks ago, the renminbi appreciated rapidly from 7.26 to around 7.2 against the U.S. dollar. At that time, exporters began to convert foreign currency into RMB. This mentality of 'chasing highs and selling lows' has always been very common among exporters, and this time is no exception." The foreign bank trader told reporters that this also pushed the renminbi higher.

In the past two years, exporters tended to keep their foreign exchange earnings in the form of US dollar deposits rather than converting them back into RMB, because the interest rate differential between China and the United States was at a historical high, and US dollar deposits could not only gain the exchange rate increase of the US dollar appreciation, but also obtain an annualized return of nearly 5%. But now this expectation has loosened.

Last Friday, the U.S. dollar index plummeted to a new five-month low of around 103. In addition to the expectation of a U.S. interest rate cut, this was also affected by the Bank of Japan's "interest rate hike + balance sheet reduction" which led to the closing of USD/JPY carry trades. The sharp drop in U.S. stocks also accelerated the return of the yen.

Jerry Chen told reporters that last week's "super week" came to an end, but the turbulent market may not end soon, and the "recession trade" may replace the "interest rate cut trade" as the main logic of the market.

The U.S. non-farm payrolls increased by only 114,000 in July (the second lowest this year) and the previous value was revised down to 175,000. The unemployment rate unexpectedly rose from 4.1% to 4.3% (the highest level since October 2021), and the year-on-year growth rate of hourly wages fell to 3.6%. All data were worse than expected. The rapid cooling of the job market and the poor performance of other economic data last week have made the market increasingly worried about the possibility of a U.S. recession and the Fed's wrong decision (maintaining high interest rates for too long), and panic has spread rapidly in the market. Therefore, under the premise that the Federal Reserve gave the green light for a rate cut in September last week, the interest rate market has even bet on the possibility of a direct rate cut of 50 basis points (BP) in September, and the number of rate cuts expected for the whole year has increased from 2 to 4.

Goldman SachsIt believes that if the August employment report remains weak, an emergency rate cut of 50BP may be made at the September meeting. The agency still expects the ultimate interest rate to be 3.25%~3.5% (currently 5.25%~5.5%), and has not changed its forecast of a 25BP rate cut every other meeting in 2025 and 2026, partly because it believes that there is greater uncertainty in economic policy after the election.

In the future, the factors affecting the RMB exchange rate trend will become more complex, including the global economy, the divergence between the Federal Reserve and the Bank of Japan, and the US election, but traders generally believe that several major trends are relatively clear: the RMB exchange rate flexibility will increase, which will also help to curb carry trades; the central parity rate and the spot exchange rate will further converge, which will help to further play the role of market regulation; from June to August each year, driven by seasonal foreign exchange purchases such as dividends and dividends of Chinese companies listed overseas, profit remittances of foreign companies, and summer outbound tourism by residents, the RMB often shows a phased depreciation trend. After the seasonal foreign exchange purchases end, the pressure on the exchange rate will be further relieved.