Deutsche – Asia FX Strategy Notes : RMB: Stress testing the flows: FXWW

From the FXWW Chatroom: RMB has quickly gone back to being front and centre of global risk sentiment, having weakened by ~6% in a relatively short time since President Trump’s announcement (14 June) about tariffs on Chinese goods, and the worsening of narrative over trade tensions. We continue to believe that China will not “weaponize” its currency as a trade retaliation tool. Why? First the stock of capital that is at risk of leaving China is sizeable. For example, according to the latest IIP data (December 2017), total liabilities (foreigners owning Chinese assets) are c.$4.6tn – FDI: $2.8tn, Portfolio: $836bn and other investments: $1tn. The more vulnerable of this lot are arguably, 1) portfolio equity flows; and 2) currency and deposits. This two alone is ~$1trn. In an environment where China is already seeing its current account surplus thin, this could tip its BoP into a notable deficit easily, like in 2016. Second, allowing notable RMB deprecation would likely dent China’s hopes of further internationalizing the RMB – and should in itself be a deterrent to using RMB as a policy option in the trade wars.

In the short term, to stabilize the flow dynamics, China could consider (1) more active management of RMB both in the onshore and offshore market, (2) fix USD/CNY lower more frequently and/or re-introduction of counter-cyclical factor (CCF) and (3) tighten offshore RMB funding.

Given the policy tail, we think USD/KRW is a good risk-reward trade in this environment, given: (1) Korea is one of the more vulnerable economies to supply chain disruptions from further trade friction, and (2) KRW has the highest beta to further RMB depreciation. We also remain bias towards long USD/TWD and have expressed this via being long CNH/TWD.

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