UBS House View Daily

Thought of the day

11.09 - China relaxes currency restrictions

It just got easier to short China's currency. The People’s Bank of China (PBoC) has dropped its requirement for banks to set aside 20% of the value of currency forward trades as a reserve, making it cheaper for investors to buy dollars and sell yuan. The move suggests the PBoC might be uncomfortable with the recent rise of the yuan, which has gained 4.2% versus the USD and 1.8% on a trade-weighted basis since end July.

But we believe the yuan’s rise will reverse, even without help from PBoC rule changes:

  • The USD is likely to strengthen near term. We believe, the market is underpricing the pace of Federal Reserve rate hikes and will have to recalibrate its expectations, which should aid the USD. Any progress on US tax reform could lend further support.
  • Following October’s 19th Party Congress,the government, we believe, will renew its efforts to limit credit creation. We see Chinese growth decelerating from 6.9% currently to 6.3% in 2Q18, and think the PBoC will guide the CNY slightly weaker to cushion growth.
  • China's current account surplus has shrunk to 1.35% of GDP from 2.4% in 3Q16. It’s now insufficient, in our view, to buffer structural capital outflows stemming from domestic residents’ desire to diversify their assets, leaving the currency vulnerable.

So we expect USDCNY to stabilize and reverse in the coming months. Our six- and 12-month forecast for USDCNY is 6.70 (6.52 currently). A more stable CNY exchange rate should support our overweight position in offshore Chinese equities.

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