Between the end of 2019 and the end of 2020, the RMB appreciated by 6.5% from 6.9762 to 6.5249 against the USD at the mid-rate. During the same period, the RMB appreciated by 3.8% against the CFETS basket exchange rate index from 91.39 to 94.84. Particularly noteworthy is the fact that between the end of May and the end of December 2020, the RMB appreciated against the USD by 8.5%, such a rapid rate of appreciation is relatively rare in history. on January 5, 2021, the RMB broke through the 6.5 mid-rate against the USD and entered the 6.4 range. There are already views that the RMB is expected to rise above 6.0 against the USD in 2021.
To make a forecast of the RMB against the USD in 2021, one needs to understand, first of all, what the reasons are for the significant appreciation of the RMB against the USD in 2020, which can be analyzed from the following four aspects.
One reason for this is the significant downward movement of the U.S. dollar index, which declined by 7.4% from 96.73 to 89.61 between the end of 2019 and the end of 2020. During the same period, the dollar depreciated against the euro, the yen and the pound by 8.9%, 5.0% and 3.0%, respectively. between the end of May and the end of December 2020, the dollar index depreciated by 9.0%. It is easy to see that the appreciation of the RMB against the USD in 2020 is still lower than the depreciation of the USD index and the appreciation of the EUR against the USD. In other words, rather than the RMB being strong in 2020, the dollar itself is weak.
The second reason is that the difference in economic growth between the U.S. and China is significantly wider in the second quarter of 2020 due to the difference in the timing of the epidemic shock and the difference in the strength of the counter-control epidemic, which in turn leads to a significant widening of the U.S.-China spread. from the first to the third quarter of 2020, China’s quarterly GDP growth rates are -6.8%, 3.2% and 4.9%, respectively, while the U.S. quarterly GDP growth rates are 0.6%, -9.0%, and -2.6%, respectively. The difference in quarterly GDP growth between the U.S. and China rebounded significantly from -7.4% in the first quarter of 2020 to 12.2% in the second quarter of 2020. The difference in growth differential naturally exacerbates the spread. The difference between US and Chinese 10-year Treasury yields widens rapidly from around 130 basis points in early 2020 to around 250 basis points in mid-2020 and continues to remain at 230-250 basis points thereafter. Such a wide spread naturally attracts large amounts of short-term capital inflows into China for arbitrage, especially in the risk-free government bond market. foreign capital inflows into the Chinese sovereign bond market exceeded CNY1 trillion in 2020.
The third reason is that the Chinese government has significantly accelerated the opening of the domestic financial market in recent years. in the second half of 2019, the Chinese government removed the investment quota limit for QFII and RQFII. In recent years, Chinese stock and bond indices have been included in the world’s most important stock and bond indices one after another. During the first half of 2020 when the epidemic shock caused significant shocks in global financial markets, both Chinese equity and bond markets performed relatively stable. To a certain extent, China’s financial markets were a rare “safe haven” during the global financial market shocks. In particular, in the bond market, the attractiveness of positive yields in the Chinese bond market was highlighted after the negative interest rate pattern in the global bond market deepened due to the epidemic shock. In other words, the accelerated opening of financial markets and the stronger performance of asset prices also contributed to the significant appreciation of the RMB against the USD.
The fourth reason is that export performance and the size of the current account surplus both exceeded market expectations. The year-on-year growth rate of China’s exports in USD terms surged from -17.2% in January-February 2020 to 21.1% in November 2020.
Regarding the reasons for the spike in export growth, one is that the global epidemic ravaged China’s medical equipment industry and telecommuting industry exports to a historic peak.
Second, the dislocation of the epidemic shock has led to a short-term rise in the importance of Chinese companies in the global industry chain from the second quarter of 2020 onwards, rather than a decline.
Third, global demand rebounded from the second half of 2020 onwards. The rise in the goods trade surplus, combined with the fall in the services trade deficit due to the epidemic shock, allows China’s current account surplus to reach $110.2 billion and $92.2 billion in the second and third quarters of 2020, respectively, a new high since the outbreak of the subprime mortgage crisis.
Will the yuan break 6 against the dollar in 2021? It depends on whether the major factors driving the yuan in 2020 will continue to work in 2021, or whether they will decay or even reverse.
Looking at the dollar index, it may have turned from bull to bear and entered a long downward cycle, but its performance in 2021 may not be too weak. After all, the dollar index measures the relative strength of the currency between the U.S. and other major developed economies. On the one hand, even under the epidemic shock, the U.S. economic growth rate is not weaker than other major developed economies. On the other hand, considering that the U.S. Democratic Party has recently gained the majority of seats in the Senate, then in 2021, it is expected that the Biden administration will adopt stronger epidemic prevention and control measures, larger fiscal stimulus policies and relatively more prudent monetary policies, which means that the U.S. economic performance in 2021 may continue to be stronger than other major developed economies such as the Eurozone, the UK and Japan. The author believes that the fluctuation range of the US dollar index in 2021 is likely to be around 84-92, with a pivotal level of 88 or below. The probability of the dollar index falling below 80 is very low.
By the third quarter of 2020, the difference in quarter-on-quarter GDP growth between China and the U.S. has contracted to 7.5% from 12.2% in the second quarter, and it is expected that the growth differential between China and the U.S. will contract one after another in the future. Recently, China’s 10-year Treasury yield has fallen, while the U.S. 10-year Treasury yield returned above 1% on January 6, 2021, and the difference between China and the U.S. 10-year Treasury yields has fallen from 250 basis points to about 210 basis points. The author believes that China’s 10-year Treasury yield will remain roughly stable at 3.0% to 3.5% in 2021, while an economic rebound and rising inflation will cause the U.S. 10-year Treasury yield to rise above 1.5%. This means that the US-China spread will continue to contract moderately in the coming period.
In terms of relative asset price performance, I am more bullish on Chinese equities in 2021. This is because U.S. equities rallied significantly in the second half of 2020 to reach another record high. US stock market valuations are currently at historically extremely high levels. As a result, it will be very sensitive to various negative shocks, especially marginal adjustments in monetary policy. And Biden’s rise to power and Democratic control of both chambers implies a higher probability of monetary policy adjustment than Republican control of the Senate. But the problem is that, from historical experience, if the U.S. stock market falls sharply, then the U.S. will not only not face a large outflow of capital, but may also face a large capital inflow as well as the dollar index rebound. And once the global financial market turmoil intensifies, China’s capital markets face “northward capital” is also likely to accelerate the withdrawal, rather than a large influx.
In terms of export performance, although global demand is likely to continue to recover, China’s export growth in medical equipment and telecommuting equipment is likely to fall back as the epidemic stabilizes, especially with the mass rollout of vaccines. The resumption of work and production in other emerging markets will also reduce the short-term irreplaceability of Chinese companies in the global chain. In addition, after a time lag, a faster appreciation of the effective exchange rate of the RMB will also negatively affect export growth. The author believes that China’s export growth in 2021 will be better than in the first half of 2020, but will most likely be weaker than in the second half of 2020.
In summary, I believe that the probability of the RMB breaking 6 against the US dollar in 2021 is small, and is more likely to fluctuate around a range of 6.2 to 6.6, with the pivotal level at around 6.4. Finally, it is worth mentioning that considering that 6.1 is the highest point of the RMB to USD exchange rate in the 26 years since the 1994 RMB exchange rate reform (also the exchange rate level before the “8-11” exchange rate reform in 2015), once the RMB to USD exchange rate breaks through 6.1 under certain circumstances, it will not be difficult to break through 6.0 again. It is not difficult to do so. Although this is a small probability event, the monetary authorities should be prepared for it.