The core logic of the appreciation of the RMB exchange rate since May 2020 is: the expected poor economic recovery between China and the United States and the return on investment.

From 7.13 appreciation in May to 6.65 in October, the renminbi has rapidly appreciated by 6.73% accumulatively, which has put pressure on domestic import and export trading companies to exchange rate fluctuations.

　　We believe that the RMB exchange rate may fluctuate in the range of 6.60 to 6.80 in the fourth quarter of 2020, and will face depreciation pressure in the short term (November to December).

　　Judgment on the current trend of the RMB exchange rate: maintain a shock of 6.60~6.80 in December

　　In summary, the trend of the RMB exchange rate depends on: 1) the difference in economic expectations between China and the US; 2) the dollar index; 3) the attitude of the central bank; 4) the interest rate difference between China and the US (theoretically, the theory of determining the exchange rate includes the function of value preservation-purchasing power parity theory) , Speculative demand-interest rate parity theory, payment function-balance of payments theory. At the same time, the non-free floating exchange rate reflects the sovereign function of the currency-that is, the exchange rate must also serve economic growth, so it will be greatly affected by policy influences).

　　1) The SHIBOR interest rate appreciation trend will slow down, and the Sino-US interest rate differential may weaken in the short term.

Cross-border capital flow is an important dimension to analyze the trend of the RMB exchange rate. It is mainly related to the Sino-US interest rate differential. The SHIBOR interest rate is also an observation variable.

At present, the strong interest rate differential between China and the United States is behind the steady recovery of China's economy and the early withdrawal of monetary policy.

As of October 24, the 3-month average interest rate of SHIBOR closed at 2.85%, the previous value was 2.75%, the average weekly interest rate of China-US spreads closed at 2.36%, the previous value 2.47%; the current 3-month SHIBOR interest rate has quickly recovered to 2018~ At the 2019 level, the 10-year Treasury bond yield has reached the pre-epidemic level of 3.2%-even if the current SHIBOR yield can continue to rise, but based on the current economic recovery-the constant price of 23.92 trillion yuan in the third quarter of 2020, This is 4.90% year-on-year and 0.70% year-on-year cumulatively. The cumulative year-on-year rate is still much lower than before the epidemic. The current interest rate rise trend should ease, corresponding to the slowdown in the appreciation of the RMB exchange rate.

　　China's central bank adjusted the reserve ratio for forward foreign exchange sales to 0 on October 12, which may mean that the recent appreciation trend has slowed.

China’s continued trade and export surplus supports the appreciation of the renminbi. This is also the need for China to make appropriate concessions to the United States in economic and trade. However, the rapid appreciation is not conducive to the sustained recovery of the Chinese economy.

On October 12, the People's Bank of China decided to lower the foreign exchange risk reserve ratio for forward foreign exchange sales from 20% to 0, which means that the current exchange rate has appreciated rapidly and the central bank has begun to take appropriate measures to deal with it.

From past experience, every time the central bank adjusts the reserve ratio for forward foreign exchange sales, it will correspond to a short-term sideways adjustment of the exchange rate. The adjustment time is generally 60 to 90 days. Therefore, after the central bank adjusts the forward foreign exchange reserve, the expected exchange rate is A 60-90-day adjustment period is expected to fluctuate between 6.60 and 6.80.

　　The economic phase difference between the United States and Europe may cause the US dollar index to face rebound pressure near 92-93 in the short term.

The U.S. economy is stronger than Europe and the trend of the Fed's balance sheet expansion has slowed down, making the dollar index depreciation trend to be supported near 92.

　　1. The economic recovery in Europe and the United States is divided. In October, the economic recovery in the United States was stronger than that in Europe, and the US dollar appreciated passively.

　　In October this year, the European Markit composite PMI was 49.40, the previous value was 50.40; the US Markit composite PMI was 53.30, the previous value was 53.20; the United States was stronger than Europe for three consecutive months, putting upward pressure on the dollar index.

As of November 15, the US-Germany spread closed at 1.49%. Since August, the US-German spread has continued to widen, putting passive appreciation pressure on the US dollar.

　　2. The cumulative value of the US-Europe Citi Economic Surprise Index continued to rise, putting pressure on the US dollar to fall.

　　As of November 12, the cumulative difference in the Citi Economic Surprise Index between the United States and Europe closed at 4467, which continued to rise and was at a historical high.

　　3. Net long positions in the US dollar index bottomed out.

　　As of the week of November 3, the U.S. dollar index has 741 non-commercial net long positions, which have rebounded from the bottom in history since September.

From the point of view of net positions, the market's pessimism towards the US dollar seems to be at a staged bottom. The US dollar index may face rebound pressure in the short term after 92~93, and the corresponding RMB appreciation trend may face relaxation.

　　From the perspective of the CFETS index, the renminbi is also facing devaluation pressure.

The multilateral exchange rate of the RMB against the currencies of major trading partners (based on the CFETS24 currency basket) soared to previous highs, which is also a reason for the possible short-term depreciation of the RMB (below).

　　The strong short-term trade surplus supports the strengthening of the RMB trend.

In the third quarter, China's GDP constant price was 4.90% year-on-year in the current quarter, and the year-on-year discount of US GDP constant price was -9.14% year-on-year. In October, China's export value was 14.50% year-on-year. In September, the US export value was -15.70% year-on-year.

　　From May to August this year, China’s trade balance was between 46 billion and 63 billion U.S. dollars, which supported the strengthening of the RMB exchange rate. In September, due to the substantial increase in imports, the trade surplus dropped to 37 billion U.S. dollars, and in October it rose to 58.4 billion U.S. dollars. This variable supports the appreciation of the renminbi.

　　We expect that in the short term in 2020 (the next 1 to 2 months), the renminbi exchange rate will fluctuate between 6.60 and 6.80.

　　Understanding of the long-term trend of RMB exchange rate

　　The RMB exchange rate is essentially the relative price between two currencies-RMB and the US dollar.

Under the assumption of free movement, the relative price of a commodity depends on the competitiveness of the commodity—behind it is the credit of the Chinese and American governments.

How to observe the credit of the two governments, on the one hand, is the level of technological and economic growth of the country, and on the other hand is the level of the country’s currency management agency—the central bank’s ability to manage the country’s currency.

　　From the above two aspects, why is the US dollar entering a weak trend?

the reason is:

　　1. The Fed's ability to control the US dollar weakens.

It should be said that the current dollar credit was established by Volcker in the 1980s. Facing the pressure of "stagflation" in the United States in the early 1980s, Volcker raised interest rates with an "iron fist"-even at the expense of Carter's resignation. At that time, the Fed was independent. Yes, the market has established trust in the Fed and the U.S. dollar.

In the current situation, the U.S. government has raised a lot of debt in response to the economic recession, causing the fiscal deficit to continue to hit record highs, while economic growth is facing challenges due to internal social conflicts and aging problems in the United States. In this case, the fiscal deficit can only be affected by currency Otherwise, the government will face the risk of default. This is a background of the Fed being kidnapped by Modern Monetary Theory (MMT).

　　As of October, the US fiscal deficit was 3.06 trillion US dollars, the previous value was 2.78 trillion US dollars, and continued to hit a record high.

The current fiscal deficit of the US federal government has reached 14.46% of GDP in 2020, which was 13.12% before and is expected to exceed 14% by the end of the year.

After the United States cancels its fiscal deficit ceiling, it will be more difficult for economic growth to make up for the increase in fiscal deficits in the short term.

　　2. The level of US technology and economic growth is facing challenges.

A representative example is that China’s Huawei 5G technology is leading the United States. This is the first time that China has surpassed Western countries in the field of science and technology in the past two centuries. China’s breakthroughs in science and technology research and development have brought industries and capital to the east. The background of trade friction is the decline of US economic power in the context of aging and social conflicts.

　　3. The renminbi exchange rate cannot be viewed simply from the perspective of the US dollar, but also from the perspective of the renminbi itself-the Chinese economy and the attitude of the central bank.

Since 2019, China's export volume has started to rise as a percentage of the world's exports, especially under the new crown pneumonia epidemic in 2020, the European and American economies have declined, and Chinese exports have assumed the inventory gap in the European and American economies, leading to a strong RMB exchange rate.

From the perspective of future trends, as China's economic volume increases in the world, the RMB's international payment positioning will be further supported, supporting the RMB exchange rate to strengthen, and may even rise above 6.0.

　　The impact of RMB appreciation on major asset investment

　　The first and most direct impact of the appreciation of the renminbi is the import and export trade, which is good for imports but not good for exports.

The appreciation of the renminbi has directly brought about the improvement of domestic residents' overseas consumption ability, which can expand domestic consumption upgrades. At the same time, the competitiveness of foreign currency-denominated export commodities has declined.

　　But not all import trade is profitable-if traders hold USD-denominated goods, they will face the problem of devaluation of the goods, such as importing 1 million U.S. dollars of copper that arrived in November, paying 670 in advance at the exchange rate in October Ten thousand yuan; when the goods arrive in November, it is still worth 1 million US dollars, but only worth 6.5 million yuan. Traders resell at 6.6 million yuan, and the intermediate trade loss is 100,000 yuan. Similar to the above situation, it is necessary to use US dollar futures or US dollar bearish Options are used as hedging to avoid exchange losses caused by the devaluation of the goods when holding USD-denominated goods (holding USD-denominated liabilities is another matter).

　　In terms of commodities, the depreciation of the U.S. dollar often corresponds to an increase in commodity prices.

Since international bulk commodities are priced in U.S. dollars, the depreciation of the U.S. dollar causes the price of corresponding denominated goods to rise. The main logic lies in: 1) Purchasing power parity theory-the depreciation of the U.S. dollar, commodities need higher prices to obtain the same purchasing power; 2) From the perspective of demand , The depreciation of the U.S. dollar increases the purchasing power of non- U.S. currencies, and demand rises; 3) From the perspective of supply, the depreciation of the U.S. dollar increases the marginal production cost of non- U.S. dollar regions, and the supply decreases.

From the above logic, commodities whose main output is not in the United States are more likely to rise in price due to the depreciation of the US dollar, such as iron ore and gold, while energy and agricultural products are relatively second.

　　In the stock market, the appreciation of the renminbi is conducive to capital inflows.

The background of the appreciation of the renminbi exchange rate is mainly due to the poor economic expectations of China and the United States. Under the expectation of a strong Chinese economy, foreign capital inflows and corporate profit growth resumes. Currency liquidity is beneficial to the domestic stock market.

　　Regarding the yield of government bonds, the appreciation of the renminbi often corresponds to stronger bond yields.

The relationship between exchange rates and interest rates is mainly linked to capital flows and risk sentiment: 1) High interest rates attract cross-border capital inflows, and RMB exchange rate appreciation; 2) At the same time, high interest rates can easily suppress consumption and investment, resulting in current account surpluses, oversupply of foreign exchange, and RMB appreciation ; 3) The RMB exchange rate continued to appreciate, cross-border capital inflows continued, and money supply increased, causing downward pressure on interest rates. Of course, under the current situation that the RMB capital account is not fully opened, the impact of cross-border capital inflows on interest rates is very small, basically because of interest rates. The exchange rate, only when the central bank does not want the exchange rate to continue to depreciate/appreciate and want to intervene, the exchange rate may have an impact on interest rates.

　　In terms of corporate exchange gains and losses, the appreciation of the renminbi will help companies with high dollar liabilities reduce the cost of current liabilities, thereby affecting exchange gains.

The appreciation of the renminbi is detrimental to customers who hold USD assets and is beneficial to customers who hold USD liabilities, such as aviation and paper making.

Because airlines have a large amount of overseas liabilities-for example, Air China's US dollar liabilities as of the first half of 2020 are equivalent to RMB 58.2 billion, accounting for 35% of total liabilities, and at the end of 2019, total US dollar liabilities are equivalent to RMB 60.4 billion, accounting for 43% of total liabilities According to the disclosure of Air China’s annual report, the exchange difference of foreign currency general borrowings is included in the current profit and loss, and the fluctuation of the RMB exchange rate will affect the value of the dollar debt, thereby generating exchange gains and losses.

According to CICC estimates, for every 1% appreciation of the RMB against the US dollar, the cost of debt will be reduced by 0.72%~0.74%, and Air China’s net profit will be increased by about 420 million to 430 million yuan. Since the third quarter of 2020, the RMB will appreciate by about 4%, which will increase. Air China's profit is about 1.5 billion to 1.7 billion yuan.

　　(Li Haitao is Professor of Finance at Cheung Kong Graduate School of Business, Distinguished Dean Chair Professor, Associate Dean of Chinese/Finance MBA Program, Lin Xi is Research Assistant at Cheung Kong Graduate School of Business)

　　Author: Lin Li Haitao ▪ tin