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since july 25, the rmb exchange rate against the us dollar has strengthened, appreciating by 2.7% cumulatively, and the offshore rmb exchange rate is close to a 15-month high of 7.08. starting from august 29, the closing price of the rmb exchange rate against the us dollar began to be significantly stronger than the central parity rate, the first time since july last year (figures 1 and 2). with the strengthening of the rmb, hong kong stocks have performed well. at the same time, the chinese concept stocks and a-share indexes have rebounded recently, and the investment sentiment of the global market for rmb assets seems to be warming up. this article briefly analyzes the potential driving factors behind the recent strengthening of the rmb, and discusses the main "observation points" at the macro level, the rmb exchange rate and the trend of rmb assets.

the recent strengthening of the rmb is the result of the mutual "catalysis" of multiple factors, which reflects some marginal corrections to the market's previous pessimistic pricing:

the recent increase in the expectation of a fed rate cut, coupled with the previous rapid strengthening of the yen, has led to a partial reversal of exchange rate carry trades represented by the yen, with a particularly significant boost to asian currencies, especially low-interest currencies. as u.s. economic data weakened, the jackson hole meeting in late august further released a clear signal that the fed will cut interest rates in september and that the urgency to stabilize growth and employment has increased (see "fed chairman's annual meeting speech: the urgency of cutting interest rates is beyond words", 2024/8/24). on the other hand, the bank of japan's unexpected rate hike on july 31, coupled with the weakening of u.s. growth expectations, led to a rapid narrowing of the u.s.-japan interest rate differential, which significantly pushed up the yen and triggered a reversal of some carry trades (figure 3). in addition to the yen, the stock of rmb carry trades has also increased due to the widening of the u.s.-china interest rate differential this year. as of august 26, the total open interest of rmb futures on the singapore and hong kong exchanges was approximately us$23 billion (approximately rmb 164 billion). the yen carry trade was partially reversed, and the rmb exchange rate, which is also a low-interest currency, strengthened. since july 31, the rmb exchange rate against the us dollar has appreciated by 2.2%, while the cfets index against a basket of exchange rates has fallen by 1.4%.

since thursday (august 29), the rmb has shown a relatively independent and strong trend against other asian currencies, which may also reflect the expectation of marginal easing of sino-us relations to a certain extent. in the past two trading days, the rmb exchange rate against the japanese yen has strengthened significantly, with a cumulative increase of about 1.2%. while the us dollar has not weakened, the rmb has appreciated against the us dollar, and the cfets index of the rmb exchange rate against a basket of currencies has also risen against the trend. the independent trend of the rmb being stronger than other asian currencies may be partly boosted by expectations of improved sino-us relations. from august 27 to 29, jake sullivan, assistant to the president for national security affairs, visited china, and china and the united states held a new round of strategic communication. after the meeting, the white house said that the chinese and us heads of state may hold a call in the next few weeks, and did not rule out the possibility of a meeting at the g20 and apec meetings. in addition, he lifeng, member of the political bureau of the cpc central committee and director of the central financial and economic affairs office, met with ray dalio, founder of bridgewater fund, in beijing on the afternoon of august 29, emphasizing that american companies should deepen mutually beneficial cooperation with china. this series of signals that china-foreign economic and trade relations are stabilizing and even recovering marginally have had a marginal boost to the market.

at the same time, there are signs of marginal acceleration in fiscal efforts recently. however, september and october may be a "window period" for further and more substantial adjustments to fiscal policy, and monetary policy may also be further relaxed. these marginal changes also have a certain boosting effect on market confidence. in july, central and local fiscal expenditures increased from -4.9% year-on-year in june to +3.7% in july. however, fiscal expenditure growth lagged significantly from march to june this year, with an average monthly decline of 1.3% year-on-year. on the other hand, central and local fiscal expenditures from january to july this year still fell by 2.1% year-on-year, significantly lower than the +7.9% year-on-year growth in the annual budget - considering that the annual total fiscal expenditure budget is 28 trillion yuan, the current annualized expenditure progress lags behind by nearly 3 trillion yuan (figure 4). the expenditure is significantly less than the budget, mainly due to the weak growth of fiscal revenue, especially the downward drag of local government revenue. therefore, the market's expectations for increasing the budget deficit or the amount of treasury bonds have increased significantly. at the same time, although the issuance of local special bonds has accelerated in august, the issuance progress is still slower than the same period in previous years, and may continue to accelerate in the future (figure 5). considering that the window period for annual budget adjustment/increase of treasury bonds is from september to october, and the constraints of this year's budget deficit on fiscal easing are already obvious, it is reasonable that the market is looking forward to marginal adjustments in fiscal policy and partially reflects the marginal changes in fiscal stance in july. in terms of monetary policy, the central bank has recently stated many times that it will strengthen countercyclical regulation and study reserve increment policy measures. if the fed cuts interest rates in september, it will also open up room for domestic monetary policy easing, especially interest rate cuts. if the interest rate of existing mortgage loans can be adjusted, there may be a marginal boost to the real estate cycle.

as the us interest rate cut approaches, the opportunity cost of holding us debt will decrease, which will help capital flow back to emerging markets. the short-term interest rate differential between china and the us is expected to narrow rapidly, which may further reduce the opportunity cost of holding dividend assets in hong kong. at the same time, it may also marginally promote the settlement of foreign exchange by domestic exporters and financial institutions. at present, with the adjustment of the market, the dividend yield of hong kong stocks has reached 4.3%, which is significantly higher than the 3% of a shares (figure 6). if the fed lowers the short-term interest rate from the current 5.25-5.5% to between 3.25-3.5%, it will greatly reduce the opportunity cost of holding hong kong assets, especially stable return products. at the same time, since 2022, with the rapid interest rate hike by the federal reserve, the short-term interest rate differential between china and the us has widened, and the willingness of domestic exporters to settle foreign exchange has continued to decline. based on the average foreign exchange settlement ratio from 2001 to 2021, domestic exporters may have more than us$540 billion (about rmb 3.8 trillion) of export revenue that has not been settled since 2022 (figure 7); even if the lower average foreign exchange settlement ratio after july 2018 (52.3%) is used, the unsettled overseas income since 2022 may reach us$100 billion (about rmb 740 billion). in a sense, reducing foreign exchange settlement is also a manifestation of the rmb "carry trade". as the interest rate gap between china and the united states narrows under the fed's interest rate cut, it is not ruled out that the rmb will reverse the carry trade periodically - and the strengthening of the rmb will further promote the willingness to settle foreign exchange. at the same time, the proportion of foreign exchange assets held by financial institutions is also sensitive to the short-term interest rate gap between china and the united states, and their future foreign exchange settlement demand may also increase (figure 8).

the appreciation of the rmb exchange rate has marginally increased the attractiveness of hong kong assets. the recent strengthening of the rmb against the hong kong dollar has undoubtedly played a role in easing monetary/financial conditions for hong kong, a small open economy. in a sense, the depreciation of the effective exchange rate of the hong kong dollar (i.e., the exchange rate against the rmb) has marginally alleviated the downward pressure on local asset prices in hong kong. as a result, a certain degree of "positive cycle" effect has begun to appear between the rmb and overseas rmb assets in recent days. because hong kong, china's largest trading partner is mainland china, its nominal effective exchange rate trend mainly depends on the exchange rate of the hong kong dollar against the rmb. since the hong kong dollar is pegged to the us dollar, the strengthening of the rmb against the us dollar means that the exchange rate of the hong kong dollar against the rmb is weakened, thus marginally easing hong kong's financial conditions (figure 9). under the linked exchange rate (i.e., currency board) system, hong kong mainly adjusts its relative competitiveness through changes in local prices and asset prices, so easing financial conditions helps to alleviate the downward pressure on local asset prices in hong kong (see "is the heat of the hong kong property market sustainable and replicable after the withdrawal of the spicy policy?", 2024/3/18).

from the perspective of trade surplus and real exchange rate, the actual exchange rate of the rmb is extremely competitive in global trade. at the relative price level, there is no fundamental support for the depreciation of the nominal exchange rate of the rmb. china's all-round cost and efficiency advantages in the manufacturing industry have accelerated in recent years (see "upgrading and reshaping of china's export industry chain", 2023/4/16). since 2020, the cumulative increase in china's ppi index in us dollars has been 30-40 percentage points lower than that of europe and the united states, and the cumulative increase in the export price index in us dollars has also been about 30 percentage points lower (figures 10 and 11). therefore, in recent years, china's share of global exports has continued to rise, and the proportion of trade surplus to gdp has also remained high, both showing that the competitiveness of the rmb has increased (figures 12 and 13). at the same time, since april 2022, the nominal effective exchange rate of the rmb has adjusted back by 4.9%, and the real effective exchange rate has fallen by 13.2%, a decline that exceeds all other depreciation cycles since 1990 (figure 14).

since china's manufacturing value added accounts for one-third of the world's total, china is the most important "marginal pricing country" in global trade. therefore, the appreciation and depreciation cycle of the rmb is completely different from that of small countries. the effective exchange rate cycle of the rmb has a relatively strong "self-limiting nature" - taking depreciation as an example, when the cumulative depreciation of the rmb exchange rate reaches a certain level, the exchange rates of other countries also need to be adjusted accordingly to offset this impact and limit the motivation for further depreciation of the rmb. on the fundamental level, the growth of china's external demand and trade surplus is difficult to maintain a "linear extrapolation" growth rate due to its large size. on the basis of china's trade surplus reaching us$822.1 billion in 2023, the cumulative year-on-year growth of china from january to july this year was 7.9%, reaching 40% of the total global trade surplus. this ratio shows that the relative price of the rmb is already highly competitive. admittedly, other factors, including carry trades, may have an impact on cross-border capital flows. for example, the reversal of carry trades when the federal reserve cuts interest rates may bring in cross-border capital inflows.

looking ahead, short-term factors, including the fed's rate cut speed, china's cyclical trends, and especially the pace and magnitude of fiscal easing, will largely determine whether the rmb exchange rate can maintain a relatively strong position. recent macro data show that the growth momentum of domestic demand and the real estate cycle are still weak. if the expectation of strong fiscal easing can be realized quickly, the relative strength of the rmb exchange rate and overseas assets in the near term may still have stamina. large-scale fiscal easing is an important support for supporting the full-year economic growth target - given that fiscal spending needs to increase by 2-3 trillion yuan annually to maintain a neutral fiscal policy intensity (i.e., spending growth and nominal gdp are basically the same). at the same time, whether the real estate easing policy, including monetary policy, can effectively stabilize real estate price expectations is also an important determinant of the rmb trend. in addition, the effective prevention and resolution of financial risks will also help stabilize the rmb exchange rate expectations. of course, if the fed's rate cut exceeds expectations, it may exacerbate the reversal of the rmb carry trade and marginally boost the relative attractiveness of rmb assets in the short term.

in the medium and long term, whether the market-oriented reform of the economy and the reform of the fiscal and taxation system can bring new growth points and efficiency improvement to the chinese economy may be the fundamental factor that determines the trend of the rmb exchange rate. the "decision" of the third plenary session of the 20th cpc central committee proposed to deepen reforms in the fields of new urbanization, land, fiscal and taxation system reform, promoting scientific and technological innovation, and expanding high-level opening up to the outside world, which will help improve resource utilization efficiency, increase total factor growth rate (tfp), and expand domestic demand more sustainably (see "comprehensive reform direction in the full text of the third plenary session of the 18th cpc central committee decision", 2024/7/22). if the reform can improve the efficiency of economic operation and continuously improve total factor productivity, it will provide medium- and long-term support for the real exchange rate of the rmb.