As the Fed enters the rate hike cycle, where does the yuan exchange rate go from here?

Since the outbreak of the Russia-Ukraine war, the RMB has remained strong against the USD while the USD has strengthened, and the Fed has opened a new cycle of interest rate hikes, can the RMB exchange rate remain as strong as ever?

Since last year, the USD/CNY exchange rate has fallen from a high of around 7.20 all the way down to a low of 6.30. Even as the USD strengthens in anticipation of Fed tightening, the RMB has shown no weakness, especially since the outbreak of the Russia-Ukraine war, global risk aversion has been on the rise, and while the USD, US bonds and gold prices have soared, the RMB has remained firm against the USD, even increasingly like a safe-haven currency. And with the Federal Reserve having started a new cycle of interest rate hikes, can the RMB exchange rate remain as strong as ever?

Renminbi assets become "safe havens"

Recently, the Russian-Ukrainian conflict and rising oil prices brought inflation risks, global financial market turmoil, many investment institutions have also reduced positions to avoid risk, resulting in various degrees of decline in national stock markets, and affected the A-share. Along with the increased volatility of the A-share market, the Hong Kong Stock Exchange funds on behalf of foreign investors recently showed a net outflow trend, the relevant data show that the net outflow of Hong Kong Stock Exchange funds from March 7 to March 15 exceeded 66 billion yuan, and the last time such a high net outflow scale or two years ago.

We were also surprised to find that the RMB exchange rate depreciated significantly during the previous panic plunge of A-shares and significant foreign capital outflows, and then appreciated rapidly after the A-share stabilization comeback, with the RMB exchange rate and A-share equity assets showing an extremely synchronized rise and fall.

As the Fed enters the rate hike cycle, where does the yuan exchange rate go from here?

From this perspective, the RMB's safe-haven properties stem from the investment attractiveness of RMB assets, unlike both the local currency status of the US dollar and the low interest rate financing and hedging trading needs of the safe-haven Japanese yen and Swiss franc.

China's economy is still growing at a relatively fast pace following the intensification of the Russia-Ukraine conflict. China's position as a global manufacturing center and supply chain advantage is once again highlighted against the backdrop of a pending epidemic, soaring energy prices and increasing global supply tensions, and relatively mild domestic inflation and high real interest rates on the RMB are the main reasons for the constant strength of the RMB.

In addition Russia's kick out of SWIFT also exposes the risk of long arm US regulation, which will accelerate the process of global de-dollarization. From Russia's foreign exchange reserve ratio, the dollar reserves have been shrinking since 2018, instead the proportion of RMB reserves has been rising, and in the long term, the RMB will trend up in international settlements and foreign exchange reserves, which also makes RMB assets attractive for foreign investment.

Renminbi under pressure to depreciate in phase

At the moment, the Federal Reserve has officially started to raise interest rates, which may trigger the return of international capital to the United States, and emerging markets, including China, are also facing a certain degree of capital outflow pressure. Investors are worried about the decline in risk appetite in global financial markets after the Fed's rate hike, including the collective reduction of equity assets such as U.S. stocks and A-shares, while the rate hike will mean a stronger dollar, a weaker yuan and a lower expected return on yuan assets. The A-shares, which have been stumbling since the beginning of the year, have the shadow of foreign capital flight.

In addition, China's economy is facing greater downward pressure, although China's industrial value added, fixed asset investment and social retail sales had data released on March 15 exceeded expectations for a rebound, but the growth rate of real estate investment remains weak in terms of subdivision data, and there are still low base for manufacturing investment and infrastructure investment. March saw another outbreak of the epidemic across China, and recent high frequency data show that Consumption may be suppressed by the rebound of the epidemic. Therefore, the economic data for January-February exceeded expectations and does not indicate that China's economy has stabilized, while the epidemic may also have a negative impact on GDP growth in the first quarter.

A key reason for the yuan's strength last year was the strong growth of Chinese exports and the continued growth of the bank surpluses in foreign exchange settlements that drove demand for the yuan, a factor that may gradually fade in 2022 as many parts of the U.S. and Europe begin to ease their epidemic blockade measures and economic activity fully recovers.

In order to stabilize economic growth, the Chinese central bank's monetary policy also tends to be loose. In the short term, various unfavorable factors are coming, and the RMB will face a phase of depreciation pressure.