When the People’s Bank of China made a one-off currency adjustment a year ago in an effort to bring a more market-determined focus to China’s exchange rate regime, the aftermath shook global stock markets.
Another currency adjustment was made this January, which led to volatility and concerns that China was losing control of its so-called managed slowdown.
But even though international equity markets have calmed down since February, financial markets have surprisingly overlooked the trend of the steady depreciation of the renminbi while the US dollar has strengthened, in Fu’s view.
This trend represents a meaningful shift over the longer term, according to Fu. The renminbi has fallen 10% against the dollar, while the dollar has appreciated 20% on a trade-weighted basis since the end of 2013.
And, according to the Bank for International Settlements, the real effective exchange rate of the renminbi remains nearly 25% overvalued.
Despite this, financial markets seem comfortable with renminbi depreciation, and there are three main reasons for this, noted Fu. First, the Chinese authorities have made efforts to improve their communications with financial markets and clarify the exchange rate regime.
Second, real GDP in Q2 was in line with expectations, exports have improved, retail sales growth remains solid, manufacturing surveys have stabilised, and fixed asset investment growth continues to slow in industries suffering from overcapacity.
Finally, capital outflows have stabilised since March of this year and foreign exchange reserves increased by US$13.5bn in June, despite renminbi depreciation and the unfavourable valuation effects of the US dollar.
Moreover, highlighted Fu, the country's central bank has hinted at further financial market liberalisation.
Going forward, a lot will depend on with Fed policy as there will be more pressure for the renminbi to depreciate if the US dollar were to strengthen, said Fu.
But, Heartwood IM does not believe we are about to enter another period of significant US dollar appreciation, especially not in a ‘lower for longer’ interest rate environment and with the Federal Reserve seemingly in no hurry to raise interest rates.