Chinese Yuan outlook : RBC

RBC Capital Markets notes:

1-3 Month Outlook - Further easing will be needed

The RMB was the only AXJ currency (with the exception of PHP) to gain ground against the USD in May. We find this surprising given early indicators for Q2 suggest a soft start (Retail sales: 10%y/y, cons: 10.4%, previous: 10.2%y/y; Industrial production: 5.9%y/y, cons: 6%y/y, previous: 5.6%y/y). 

In response, PBC has cut benchmark interest rates three times since November (1-year lending rate cut by 90bps to 5.1% and 1-year deposit rate cut by 75bps to 2.25%). It has also lowered banks' reserve requirement ratio (RRR) two times since February (by 150bps to 18.5%). 

However, nominal rate cuts are not keeping pace with disinflation (PPI: -4.6% in April) and real interest rates remain far too high. In addition, sustained capital outflow from China since June 2014 has tightened domestic liquidity. There has been limited evidence that interest rate and RRR cuts have boosted credit demand. 

In April, total social financing of RMB1050.0bn (cons: 1204.0bn) and new loans of RMB 707.9bn (cons: RMB903.0bn) were disappointing. Arguably, PBC is behind the curve, and Reuters reported that the government is eyeing "a package of measures to stabilise growth and control risks". We agree that it is likely China will announce some fiscal measures to support growth. 

The most important point to remember is that any fiscal support will be fundamentally different from that of 2008/09. Fiscal policy is constrained and the onus is on monetary policy. We expect further benchmark interest rate cuts, RRR cuts and widening in the USD/CNY trading band.

6 - 12 Month Outlook - USD/RMB higher, but RMB a regional outperformer

Narrowing growth and interest rate differentials suggest the gravitational pull in USD/RMB is higher. But we think RMB has scope to be one of the outperformers in the region. We expect RMB to be included in the IMF's SDR basket this year. 

FTSE and MSCI will also be taking a staggered approach to adding Mainland shares to their global indices. Inclusion should support RMB to the extent that it could encourage reserve managers/SWFs to raise allocations toward RMB denominated assets, but an important mitigating factor will be looser restrictions on domestic capital outflows and a more flexible exchange rate (wider daily trading band) that responds to weaker macro fundamentals.