First, we must admit that our prior CNY call was wide of the mark.
Back when the onshore yuan cracked the 7.00 level in August we released a note labelled “rethinking CNY and risk appetite” where we believed the PBOC would weather the speculative pressure and gradually place the fixing lower until ultimately it traded around the 7.00 level again.
The PBOC did lean heavily on the countercyclical factor, as expected, but did not begin to lower the yuan’s trading range substantially as we originally thought.
This was in part due to deteriorating economic data and investor sentiment, along with the easing of financial conditions by the PBOC to mitigate the impact of trade measures.
For that reason, our forecast that USDCNY would return trading around the 7.00 level in the short-run was overly bullish.
The measurement of the countercyclical factor back in September when USDCNY hit decade highs highlights the PBOC’s lack of appetite for a materially weaker yuan; their fixing decisions capped onshore trading below the 7.20 level.
If recent events are anything to go by, a dramatic deterioration in trade talks would need to occur for this upper bound and the PBOC’s resolve to be tested, supplemented by the inevitable downturn in domestic data too. However, another breakdown in relations of the sort that pressured the 7.00 level would prove mutually destructive.
Due to this, we believe the prospect of another breakdown in tensions, an increase in pre-existing tariffs and a more prolonged trade war is slim – especially with the US economy showing signs of fatigue as well.
This has recently become more relevant with soft concessions from the Chinese as negotiators head to Washington prior to the October 15th tariff increase. Our CNY forecast is in effect a function of our base case in US-China trade relations.
We maintain our stance that a trade deal in 2019 is unlikely, and that a deal is more viable in the first half of 2020 prior to the US Federal elections in November 2020 – as per Donald Trump’s latest tweets.
However, recent events such as the impeachment process in the US and the deterioration of soft data such as the ISM surveys has increased the subjective probability of a deal in 2019.
Under the base case, we expect USDCNY to continue trading at current levels until the end of the year with a marginal improvement down to the 7.10 mark as additional tariffs are put on ice and negotiations enter another constructive period.
The APAC summit in mid-November is where a breakthrough, or even a narrow preliminary trade deal, may occur. Until then, we expect CNY to act as a buffer against tariffs, trading in the mid-point of the 7-7.20 range.
It must be noted that we haven’t changed our call on the Indian rupee from our August update, ultimately rolling our forecast forward one period.
In Q3 we ranked 5th in Bloomberg’s Q3 2019 rankings along with Reuters 5-month ranking for September.
Growth concerns remain prominent in our view for the Indian rupee, and continue to drive monetary policy decisions along with fiscal policies. With monetary policy under the previous transmission mechanism taking around 3-4 quarters to take effect, the Indian economy is only beginning to benefit from cuts at the beginning of the year.
Although it must be noted that improving interbank liquidity conditions and repo rate-linked loans to retail customers and SME’s will likely speed up the transition in the coming months. In this context the 135 basis point stimulus will begin to become more supportive of economic activity at the back-end of the year.
Monetary policy can’t do all of the heavy lifting, however, and this was recognised by the Modhi administration leading to the reduction in corporate tax rates.
The rebound in growth may not return trend levels to the previous elevated rate. This was highlighted by the RBI when they revised down their 2019 GDP forecast from 6.9% to 6.1% for 2020.
With growth stimulus unlikely to show the true effects on lagged data until the back end of the year, we have maintained our forecast of 71.00 for INR for October.
As corporate tax cuts, lightening trade conditions as per our US-China trade base case, and monetary policy easing begin to take effect on the Indian economy, we believe INR will trade down towards 70 by the end of Q4 2019.