FX Flash. CNH: Pressured By The Equity Rout. MACRO FX RESEARCH China. 9 Jul 2015

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1 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 MACRO FX RESEARCH China D 9 Jul 2015 FX Flash CNH: Pressured By The Equity Rout USDCNH touched a high of on Wed. The persistent decline in A-shares despite multiple measures unleashed by the Chinese government to support the domestic equity markets is a sign of a real hit in confidence at home and abroad. It is clear that the current bond rout is the main driver of CNH weakness. There are other factors too including the convergence of CNH Hibor and SHIBOR and lower interest rates generally lower demand for yuan based on the uncovered interest rate parity theory. Bearing in mind that this is a reaction to the stock market in a phase of volatility, we expect the stock markets to eventuality stabilize. When calm has returned to the markets, we expect CNH to revert towards the stable CNY. GM FX Research Saktiandi Supaat saktiandi@maybank.com.sg (+65) Fiona Lim Fionalim@maybank.com.sg (+65) Christopher Wong wongkl@maybank.com.sg (+65) Leslie Tang leslietang@maybank.com.sg (+65) CNH attempts to break away from CNY USDCNH touched a high of before reversing lower to levels around as we write late Wed (8 Jul). The persistent decline in A-shares despite multiple measures unleashed by the Chinese government to support the domestic equity markets is a sign of a real hit in confidence at home and abroad. In the past two days, the CNH traded at a discount of ~100pips to CNY, signifying not only the absence of CNY appreciation expectations but more downside pressure on the CNY beyond the near-term. Chart 1: CNH Trades at An Increasing Discount to CNY CNH-CNY Gap (lhs) USDCNY Curncy USDCNH Curncy CNH Premium to CNY CNH Discount to CNY SEE PAGE 5 FOR IMPORTANT DISCLOSURES

2 Historical records have shown that this is not unusual. The CNH has deviated from the CNY, especially during periods of yuan weakness. However, what is different from before is China s determination to keep the CNY stable to up its chances of SDR inclusion. Sources of pressure on CNH It is clear that the current bond rout is the main driver of CNH weakness but curiously, the CNH remained in a tight range even for the past two weeks when Shanghai Comp started to fall. We think that the CNH was supported by tighter liquidity conditions in offshore yuan market. However, persistent declines in the onshore equity markets have shaken confidence and the demand for CNH as well. This is evident as the sell trades executed in the northbound channel of the Shanghai-Hong Kong Stock Connect spiked only recently. Chart 2: SSE-SEHK Northbound Daily Sell Turnover Spikes Only Recently In addition, CNH SHIBOR has converged to HIBOR after PBOC delivered multiple cuts to benchmark interest rate and required reserve ratio. While this is progress in capital account liberalization efforts, it eliminates incentive for onshore investors to raise funds in offshore yuan centers rather than onshore. Chart 3: Convergence of CNH Hibor to SHIBOR Weakens CNH Demand CNH Hibor SHIBOR Jul

3 On top of that, lower interest rates will add downside pressure to the yuan according to simple uncovered interest rate parity theory. CNH CNY Sustainable? Bearing in mind that this is a reaction to the stock market in a phase of volatility, we expect the stock markets to eventually stabilize. When calm has returned to the markets, we expect CNH to revert towards the stable CNY. In the meantime, CNY is likely to remain in the iron grip of PBOC for reasons that we mentioned more than once 1) to up the chances of SDR basket inclusion; 2) to stem capital outflow and a stable yuan is all the more needed to ensure capital outflow does not turn into capital flight in the current sentiments of the domestic equity markets. Hence, while history has told us that the CNH could lead CNY lower, we do not think that is the case this time. In the near term however, CNH could remain at a discount to CNY. Chart 4: 1Y NDF 1M NDF Spread Widens, Temporary Pressure on CNY Events to Watch It is quite clear that the latest selective RRR cut and interest rate cut were not sufficient to calm domestic markets. However, we think it could be time to pull ALL stops especially ahead of 2Q GDP due next week (15 Jul). Another 50 bps cut in RRR could be delivered this weekend with additional liquidity provided for city commercial and rural commercial banks. Key to this equity rout is its negative wealth impact on consumers that might jeopardize the 7% growth target. According to available data in 2013, 9 Jul

4 proportion of shareholding by tradable market capitalization for individuals is 22% vs. corporation 63.6%. Expect the proportion of individuals to increase since bull market from last Nov. The equity rout started in second half of Jun and that might have repercussions on consumption in 3Q. More monetary easing is thus needed to support household demand. Chart 5: Daily USDCNH Attempts to Break Out of Recent Range 1 Month View for USDCNH: Mild Upside Risks towards Month View for USDCNH: Mild upside risks towards 6.22 with potential to undershoot. 6 Month View for USDCNH: Jul

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