Chinese Renminbi: Still a one-way bet?

07 Jul 2021

Almost everybody wants exposure to the renminbi these days. Here are three major factors supporting further RMB appreciation, as well as two key risks for the seemingly one-way trade

Our Bullish Case

#1 Chinese trade surplus with the US and Europe has widened despite all measures

Despite the best efforts of EU leaders and both the Trump and Biden administration, their trade deficit with China has widened over the past year. The oft-talked about reshoring of US businesses back to US soil is also simply not happening, as US manufacturing and businesses trail several Asian economies in terms of competitiveness.

Overall, a strong current account surplus led by China’s unstoppable export sector has acted as a positive driver for the yuan in the past quarters.

A note of caution may be sounded here however – recent trade statistics for April show the US trade deficit with China retreating from record highs seen in March, with consumer demand for Chinese goods seeming to lead the decline.

#2 Chinese regulators recognise that an appreciating yuan will help offset imported inflation

China’s headline inflation numbers have been on the rise, particularly in the manufacturing sector. Raw material input prices have been soaring thanks to incredible pent-up demand globally, driving producer prices through the roof, and threatening to pass higher prices on to consumers.

Since May, Chinese officials have dialled up the rhetoric on controlling imported inflation, raising the outlook of the renminbi.

#3 China’s economic growth lets them afford a different – more attractive monetary policy

Coming at the same time as regulators raising yuan allocations to foreign investors, a whole host of big-name foreign institutions have been flocking to Chinese assets. Chinese long-term bond yields are holding above 3% compared to 1.5% for the USA, setting up a torrent of money flowing into China, and in turn strengthening the currency (and attracting even more foreign money).

Our Bearish Case

#1 Risk: Chinese regulators may not be able to stomach an even stronger renminbi

The renminbi has been spinning its wheels recently, with signs emerging that regulators are quietly stepping in to curb further yuan appreciation. A stronger yuan would likely add to financial stability risks, with Chinese currency regulators recently using language such as “doomed to lose” to describe renminbi bulls.

#2 Risk: A strengthening US dollar thanks to brought-forward tapering expectations

While China’s economic rise has been positive for the renminbi, the USA is currently undergoing an economic boom as well. Everywhere one looks, they can see signs of an economic recovery (apart from the labour market perhaps).

More importantly however, recent red-hot economic activity has seen US regulators and investors wrangle over rising inflation statistics, likely putting pressure on the Federal Reserve to bring forward rate hikes earlier than expected – a bullish case for the dollar.

Our Takeaways

Overall, the days of a one-way appreciating renminbi appear to be numbered, with the currency seeming to have hit a bottom in 2021. Factors key to further appreciation have lost steam in some areas, while key developments overseas – particularly a global economic recovery, will act as a hefty counterbalance against the most optimistic renminbi bulls.

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1) Has the ARKK been sunk?

ARK Innovation ETF (ARKK) ARKK is an actively managed ETF by ARK Invest that invests in a range of companies based on their innovative and industry-disrupting potential. ARKK’s largest holdings are in companies such as Tesla, Square, and Zoom. ARKK is down around -33% from peaking on 12th Feb and is currently in the red for the year to date as the market experiences a risk-off outflow of funds. Superstar fund manager Cathie Wood has however been consistently doubling down on her bets, buying even more shares in growth stocks that are going through their own tumultuous periods such as DraftKings, Peloton, Teladoc, and Tesla. In her view, ARKK is playing the long game, and remains steadfastly convinced in the long-term prospects of these growth stocks beyond this current bout of volatility. Similarly on outflows, investors are still betting big on ARKK as ARK Invest has only lost about $1.2B in assets this year across all its six funds, compared to seeing an inflow of $15.1B during the same period. Recently, investors have been nervously eyeing ARKK’s basket of tech stocks as their future earnings potential remain vulnerable to erosion through high inflation – the dominant concern of the market in recent weeks. As commodities – the major contributor to the recent heightened inflation fears – drops sharply from record highs, are investor concerns over hyperinflation overblown?

2) Searching for exposure to Asian equities?

iShares MSCI Asia ex Japan ETF (AAXJ) The AAXJ is currently trading -10.6% adrift of all-time highs seen in February, giving up gains in tandem with an Asia-wide equity sell-off at the time. Given that slightly over 40% of the ETF’s holdings are based in China, the ongoing tumult seen in Chinese equities currently have carried over nearly perfectly in the AAXJ, as Chinese investors take a breather after the stellar gains made over the past year. Looking ahead, Asia – and particularly China, is steaming ahead with its economic recovery. China is widely expected to be one of the best-performing major economies this year, providing a major boost to the outlook for corporate earnings. As the rest of Asia and the world gradually opens up their own economies, AAXJ is likely to again benefit from strong Asian outperformance amidst a strengthening trade outlook.

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