Daiwa: "Round Two Of China Capital Outflows Is About To Begin"

Now that all eyes have turned on China eager to find how it will react to a potential Fed rate hike in June or July, the question is whether the sharp Chinese devaluation unveiled overnight, which sent the Yuan to fresh 5 year lows, will be a one-off event, and whether the PBOC will intervene far more aggressively in the offshore CNY market to keep FX market turmoil to a minimum.


According to at least one person, the answer is no.

As Kevin Lai, HK-based chief economist of Asia ex-Japan at Daiwa Capital Markets writes in note released overnight, round two of China capital outflows is about to begin, if second half last year was considered the first round.

This is what he believes will happen next:

  • China’s FX reserves may fall below $2t in about a year
  • Downward pressure on FX reserves is most likely to be underestimated as short-term speculative flows are far more ready to leave than real flows
  • Based on estimates, about 49% of PBOC’s FX reserves are made up of flows which are speculative and short-term in nature
  • Expects decline in FX reserves to be more rapid in next 24 months at least
  • Look for further $500b decline to $2.7t by end-2016 and a further $900b decline to $1.7t by end-2017
  • If companies, especially SOEs, face trouble paying back creditors, central government would bail them out
  • Massive bailouts would require government’s monetary policy to turn a lot more aggressive, putting more pressure on yuan
  • Policymakers would have to seriously think about letting CNY slide gradually to a better equilibrium level

His conclusion: the USD/CNY will hit 7.50 by end-2016, some 15% higher than where it is now.

* * *

Others currency strategists were somewhat more sanguine on what happens in China next. Here are several sellside opinions, via Bloomberg:

HSBC (Wang Ju, senior FX strategist)

  • PBOC has found a “good time window” to weaken yuan, with risk appetite supportive, volatility low and credit spread tight
  • Momentum on EM is boosted by gains in equity markets in U.S. and Europe
  • PBOC will stop CNY falling if see pressure spread across Asian assets
  • Narrower CNH-CNY spread is policy-makers’ target; NOTE: Gap now only around 50 pips
  • USD/CNY may rally near term, reaching 6.6 vs dollar end-2Q

Rabobank (Michael Every, head of financial markets research)

  • Weaker fixing is a delayed catch-up by PBOC as other Asian currencies have dropped in recent days on increasingly hawkish Fed
  • China pegging yuan to USD can’t last
  • FX intervention may be going on to “convince” market not to worry despite weaker fixing
  • Forecasts USD/CNY at 7.10 by yr-end

Mizuho Bank (Ken Cheung, Asian FX strategist)

  • Weaker yuan fixing today shows PBOC is allowing currency to decline at gradual pace vs USD
  • Fixing largely in line with expectations

Standard Chartered (Eddie Cheung, Asia FX strategist)

  • CNY fixing is a natural reaction to dollar strength overnight
  • Buoyant global equity markets indicate risk-on attitude
  • Yuan reference rate could have been weakened even further

Saxo Capital Markets (Kay Van-Petersen, global macro strategist)

  • Markets are calm now but there is serious risk of selloff with Fed rate hikes potentially on horizon
  • Better for PBOC to be proactive in devaluing yuan now rather than being forced by market to do so later
  • If China opens bond market and improves transparency and rule of law, could attract a lot of capital, offsetting outflows

One thing is clear as DB confirmed earlier today: the fate of the June rate hike is now in the hands of China.